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What will it take to get U.S. equities up on the year?

Originally posted on The Convergex Blog.

Summary: Even with today’s “Forget the Fed” rally, the S&P 500 is still down 3.9% year to date.  With 75 trading days left in 2015, we’re hearing one question more and more: “What will it take to get U.S. equities up on the year?”  Today we answer that question by disassembling the index into sectors and “heavyweight” stocks. For example, just getting the Financials sector back to flat (it is currently down 5.4% YTD) wouldn’t do it. At a 17% weighting in the S&P 500, that would only be 0.9% incremental performance.  Even if Financials end the year up 10%, that would only add another 1.7%.  Still in the red, so we’ll need to look elsewhere. Energy, down 19.8% YTD, is a logical place to hope for a bounce, but even if that sector rallied all the way back to flat for 2015 in one day, its current 7% weighting would only go to 9%, and still leave the index down on the year.  The one sector that can make the difference is technology, which at a 20% weight in the S&P 500 can most easily push us back into black for the year.  Tech is currently down 1.1%; get the group to +10% on the year (adding 2 percentage points for the index) AND get Financials up 10%, and you’re basically back to flat. Yes, some combination of many sectors pulling the load will help, but some group has to lead.  

Pop quiz time.  You probably know that the S&P 500 is up 5.9% since the August 25 lows, but do know which sectors really pulled their weight to get the market out of that seeming death spiral last month?  Turns out there are just four:

Technology, up 8.4%

Energy, up 7.3%

Consumer Discretionary, up 6.8%

Industrials, up 6.5%

By comparison, Utilities are actually lower by 0.4% from the late August market lows, and four sectors (Financials, Consumer Staples, Materials and Telecomm) are all up less than 5%.  Health care is up 5.1% since then.

Next Question:  How many of the top 11 individual names by weighting in the S&P 500 have outperformed since those same August 25th lows? You know the ones we’re talking about…  Apple, with a 4% weight (more than all the Utility companies in the S&P 500), is an important stock in the index, but so is the combined GOOG/GOOGL (2.1% of the S&P) and Microsoft (2.0% weight). The answer:

Eight of the top 11 names (in total almost 20% of the entire index by market cap) have actually outperformed the S&P 500 since the August 25 lows.

The list: Apple (up 12.1%), Google (up 9.1%), Microsoft (up 8.7%), ExxonMobil (up 6.6%), GE (up 8.7%), Well Fargo (up 6.9%), JP Morgan (up 6.9%), and Amazon (up 12.0%)

Pfizer performed roughly in line (up 5.8%)

Only two names have underperformed from late August to today’s close: Johnson & Johnson (up 4.0%) and Berkshire Hathaway (up 2.6%)

Why 11, and not 10 names?  Google’s dual classes of stocks makes any “Top 10” S&P name list problematic, since if the company had one class it would be in the Top 10.  In its current manifestation, you need to add both together.  

So, final question: is the rally from the lows a function of money flows into growth names (tech and consumer) and a bounce in oversold groups (energy and industrials)?  Or is it just a mega-cap biased asset allocation trade into U.S. stocks?  This reminds me of the old “The Holy Roman Empire was not holy, nor Roman, nor an empire.  Discuss.” (In case you’ve forgotten, it was German, limited in ethnographic makeup, and remarkably corrupt.)

Nonetheless, this parlor game/trivia contest has a purpose: its structure is useful in solving the puzzle called “Can the U.S. stock market get back to flat on the year?”  With the S&P 500 down some 3.9% as of the close today and just 75 days until the New Year, time is not exactly on the market’s side. Throw in the typical seasonal fireworks around October, a still volatile crude oil market, and the uncertainties over the Chinese economy, and you’ve got the makings for a spicy end to 2015. Oh, and someone said the Fed was meeting on Thursday. That might be important as well.

While there might be 502 equities in the S&P 500 (don’t ask…), and 10 major industry sectors, like in Animal Farm “Some are more equal than others”.  For example, three sectors comprise half the index: Technology (20%), Financials (17%) and Health Care (15%).  The ten stocks by market cap comprise 17% of the index, and lump in the two classes of Google stock and you get over 19% of the S&P 500 tied to the fortunes of just 2.2% of the companies in the S&P.

So let’s go shopping through the Index and come up with “Back to flat for 2015”.  Here are three ways to get there:

Technology is down 1.1% for the year to date, and at 20% of the S&P 500 by market cap/weight, it’s the logical place to start.  To erase the market’s 3.9% decline, while leaving everything else unchanged, would require the tech sector to rally 20% (3.9/0.20).

Financials are the second most important group, so let’s try there. The sector is down 5.4% year to date, despite being a theoretically great way to play a steepening yield curve as bond markets factor in a Fed rate cycle.  At a 17% weighting, the group would need to rally 23% from here if it were to pull the S&P into positive territory for the year.

How about the beleaguered Energy sector?  Down almost 20% (19.8%, to be exact), it could rally all the way back to unchanged on the year and the S&P would still be down. That’s because at a 7% weight (which would go to 9% with that kind of rally), a 25% move would only move the Index 2.3% higher.

Now, obviously no one sector will be the market’s savior, so we’ll need a mix of industry performance to lift U.S. equities into the black once again.  We saw such a combo platter of results from the August 25th lows we described earlier.  Some final thoughts:

It is hard to put together where U.S. stocks go green on the year that doesn’t include Technology and/or Financials. The former is going to need some confidence about economic growth in 2016 (both consumer and business spending), and the latter needs that plus a steepening yield curve. Remember: these two groups are 37% of the index.

Energy stocks may provide some leadership in a rally led by stabilizing crude oil prices, but theirs is more a sideline cheering role than a player on the field.  At just a 7% weight, the group is too small to do any serious lifting and two names – ExxonMobil and Chevron – are 2.5% of the S&P 500 on their own.  

In summary, while an S&P 500 that is down 3.9% may seem like an easy reach back to unchanged and then up on the year, in reality it’s not that simple. We’ll need to see real confidence in tech spending for next year AND general consumer trends AND a steeper yield curve to move the needle on enough of the Index to really turn things around.

Closing out on a more positive note about those “Top 11” S&P 500 names we mentioned… Their average one year forward P/E is just 14.5x, and their average dividend yield is 2.2%. Those kinds of statistics explain why they led the bounce from late August. Whether they can propel the top of the index list from here remains to be seen. Read more and sign-up for our daily email here. 

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The Dow in 10 Numbers: Current Valuation Metrics and Company Fundamentals

By Nick Colas, Chief Market Strategist at Convergex

Summary: Today, the number of the Beast showed itself again on Wall Street…  On March 9th, 2009 the S&P 500 hit its post-Financial Crisis intraday low at 666; today, the Dow Jones Industrial Average closed at 15,666 after a nasty intraday reversal.  Coincidence?  Or a sign that high frequency trading algos have a favorite number?  We’re going with the former (for now, anyway).  Still, there are some numbers surrounding the Dow that do help put the recent pullback in context and inform where we are on U.S. stock valuations.  For example, the typical Dow stock now trades for 15.5x this year’s earnings and 14.0x next year.  Not cheap, but no longer the 18x earnings we had with the Dow at +18,000.  Dividend yields – and every Dow company has a quarterly payout – are 2.3% on the Average versus 2.13% for the 10 Year Treasury. Bottom line: market action tells you the next 1,000 points on the Dow may well be lower, but at that point we’re getting to levels where the fundamentals show compelling value.

Ever since the March 2009 meltdown for U.S. stocks, traders have called the panic on the 9th of that month “The Devil’s Low” because the S&P 500 went right to 666 and reversed, intraday, like it had seen the Beast itself. The origin of that number as a sign of the devil comes originally from the book of Revelations in the Bible, but it crops up elsewhere in less ominous circumstances. Roulette wheels in casinos, for example, always total 666. Six is also a lucky number in Chinese business culture, which perhaps bodes well for the overnight trade this evening.

While we are waiting for the recent market volatility to flush its way through the system, we thought it would be instructive to take the “666” Dow low and see what this oldest of all stock market measures had to say about current valuation metrics and company fundamentals. We went with a list of 10, rather than 6…  Here they are…

The Dow in 10 Numbers:

Current P/E multiple: 15.5X 2015 and 14.0x 2016 Estimates.  The brokerage analysts that cover these names do not expect any company in the Dow to post losses in 2015 or 2016, including the energy and commodity names.  At the Dow’s peak of +18,000 earlier this year, valuations were 18x current year.

Current Yield is 2.3%, or above the 10 Year Note yield of 2.1%.  Every single Dow stock pays a dividend. We’ve done some historical analysis on stock versus Treasury yields going back to the 1970s in prior notes, and at current levels the Dow stocks are slightly cheap to bonds based on post-2007 norms. The more customary yield ratio is 1:1.

Year to Date performance: negative 12.1%.  Energy names have hurt, of course, (Chevron down 37.6% and ExxonMobil down 25.7%), but so have Wal-Mart (down 26.5%), Intel (down 28.7%) and Dupont (down 30.1%). The best names year to date have been UnitedHealth (up 8.8%), Nike (up 7.7%) and Home Depot (up 5.7%). Only six Dow stocks are up on the year, showing just how thin leadership has been in these “Super cap” names.

Analysts basically have a “Take-em-or-leave-em” view on the 30 Dow stocks.  Of the 818 sell-side recommendations on these names, only 48% rate a Buy or Strong Buy recommendation.  The most loved names are UnitedHealth (86% Buy/Strong Buy) and Visa (80% Buy/Strong Buy) – both are up on the year.  The least favored names are: IBM (only 14% Buy/Strong Buy), Travelers (19%) and Wal-Mart (23%).

Earnings growth this year versus 2014 should be flat, or up 2.1% if you exclude ExxonMobil, Dupont and Chevron. Given that the year is half done, that number seems pretty solid.  

Next year, analysts expect earnings growth to resume, with the average Dow name increasing their reported Earnings per Share by 10.4%. Only 1 Dow name is expected to post negative earnings comps in 2016: Caterpillar. Granted, analysts do tend to be pretty optimistic this time of year as their valuation work turns to out-year earnings estimates. We’d be more comfortable projecting 3-5%, which would still be an acceleration from this year’s result.

The news isn’t so positive about the upcoming quarter, where analysts expect a 6.9% decline in reported Earnings per Share. Exclude the Energy names and Dupont, and the results should still tip the scales to a decline (1.5%). Since companies like to beat by 3-5%, however, we’d look for positive EPS growth to the tune of low single digits by the time the final companies report in November.

Since the Dow is price weighted, the top 10 names constitute 59% of the Average.  These stocks, which include Goldman Sachs (at a 7.8% weight, the most important company in the Dow), IBM (at 6.0%, the #2 name) and 3M (5.8%, in third place), are slightly more expensive than the Dow as a whole. Their P/E based on 2015/2016 EPS is 15.8x/14.3x versus 15.5x/14.0x for the entire Average.

The five highest yielding names in the Dow are currently: Chevron (6.1%), Verizon (5.0%), Caterpillar (4.3%), ExxonMobil (4.0%), and GE (4.0%). These would traditionally be called the “Dogs of the Dow”, but market mythology only really has an opinion about buying such names at year end rather than the end of August.

The key takeaway: as measures of U.S. equity valuation, the numbers show a market that is becoming reasonably priced.  That doesn’t mean the selling is over, regardless of that “666” close. Originally posted on Convergex.com.

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How Big Brokers and Banks Use Twitter to Build Their Brands

By Jessica Rabe. Originally posted on Convergex.com. 

Summary: Do you follow your bank or broker on social media?  Probably not, but even the very largest U.S. financial institutions are doing their best to see that you do. Why?  In light of the hordes of startups disrupting the financial services industry, platforms like Twitter give old-school firms visibility with their next largest customer base after Baby Boomers: Millennials. We analyzed the Twitter accounts of ten major banks/money management firms to understand how they are using social media to hold and gain market consumer banking/brokerage share. After sifting through hundreds of posts, seven clear themes appear: philanthropy, customers, financial education, the environment, service offerings, events (i.e. sport tournaments), and games/prizes (i.e. teaming up with BuzzFeed to give followers fun quizzes). These financial services companies aim to demonstrate that they give back, value customers, care about the environment, and are fun and relatable. They also want to educate customers and highlight services that can help further their financial goals. Whether they’re succeeding is another story, but if you cover banks or money management firms, look at their Twitter accounts – it says a lot about their relationships with clients. Or at least what they want them to be.

Seven years after the 2008 financial crisis, banks still lack the confidence of the American public. Consider these survey results (links at the end of this note):

Only 28% of adults (aged 18+) out of 1,527 express “a great deal” or “quite a lot” of confidence in banks, according to Gallup as of this past June. This level of confidence exceeds the low of 21% in 2012, but falls below the two decade high of 53% in 2004 and the average of 40% from 1979 to 2015.

“All four of the leading banks are among the ten least loved brands by Millennials” according to a Viacom Media study that surveyed +10,000 individuals aged 18-34 over three years. Moreover, 73% percent would rather look to Google, Amazon, Apple, Paypal, or Square than their nationwide bank for financial service offerings; 33% don’t think they’ll even need a bank in five years.

Banks are not alone in terms of dissatisfaction on the Millennial front – this cohort distances itself from all kinds of social institutions. Fifty percent of Millennials label themselves as political independents, while about three in ten (29%) claim they are not affiliated with any religion, according to Pew Research Center surveys of 1,821 adults aged 18 to 33 from last year. The Pew Research Center noted “these are at or near the highest levels of political or religious disaffiliation recorded for any generation in the quarter-century” that it has polled on these topics since 1990. Additionally, only 19% of Millennials “say most people can be trusted” compared with 40% of Baby Boomers (born 1946-1964) and 31% of Generation Xers (1965-1980).

If millennials disassociate themselves from institutions and maintain low social trust, why would they have faith in banks – particularly after the scars of the most recent financial crisis? While banks remain aware of these negative perceptions, they now wield tools to help combat poor public opinions through social media. So how have they taken advantage? We focused our analysis on ten banking/money management firms and their use of Twitter – an efficient means of disseminating quick information with a potentially wide reach. Here is a breakdown of key stats for each:

Chase: Joined in March 2011 (+18.3K tweets, +300K followers).

Citibank: Joined in October 2009 (+6.8K tweets, +252K followers).

Vanguard: Joined in July 2009 (+15K tweets, +192K followers).

Wells Fargo: Joined in March 2007 (+8.2K tweets, +169K followers).

Fidelity: Joined in August 2009 (+9.6K tweets, +164K followers).

E-Trade: Joined in April 2009 (+5.5K tweets, +43.3K followers).

Schwab: Joined in April 2010 (+10.3K tweets, +55.6K followers).

TD Bank: Joined in August 2009 (+54.5K tweets, +34.6K followers)

Wealthfront: Joined in May 2008 (+5.8K tweets, +20.2K followers).

Betterment: Joined in August 2009 (+6.2K tweets, +17.2K followers).

Most firms joined after the financial crisis with the exception of Wells Fargo, and have garnered about 150,000 followers on average (excluding the two automated financial advisers). Some companies may register figures near or above widely read financial blog Zero Hedge (+274K followers), activist Carl Icahn (+240K), and the Federal Reserve (+284K), but they pale in comparison to Caitlyn Jenner (+2.85 million followers), One Direction (+24.7 million), and Donald Trump (+3.79 million), for example. While it’s a start, each bank needs to bolster their efforts given that their followers of less than 300K represent a small fraction of their millions of customers. They need to increase their presence in order for Twitter to actually act as an effective tool. With that said, all ten firms listed post at least a few times a day, signaling they recognize Twitter as an important vehicle for customer outreach. With regards to content, we categorized posts into seven key themes and assign our grade from the viewpoint of millennials: Philanthropy, Customers, Financial Education, Environment, Service Offerings, Events, and Games/Prized. Full analysis and ratings can be found in original post here. 

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7 Key Themes Surrounding Investments in Fintech

Original post on Convergex.com.

Financial services will dramatically evolve over the next ten years as millennials age and use more banking services compared to the last fifty, enabled by advancements in technology. No doubt traditional banks remain entrenched and there’s a plethora of regulatory hurtles standing in the way of this industry and new entrants. Numerous startups, however, have created more efficient, cost effective, and tech savvy versions of the verticals currently on offer. We tracked the “smart money” – Google Ventures, Andreessen Horowitz, Accel Partners, Index Ventures, Sequoia Capital and Kleiner Perkins Caufield & Byers, for example – and identified seven key themessurrounding their investments in Fintech with some examples of each, included below. (All data was derived from CrunchBase).

Money Transfer: Two dominant players include TransferWise and WorldRemit. The former – founded in London during 2010 – is “a peer-to-peer money transfer service allowing foreign students and businesses to transact money globally”. This firm has raised $90.4 million in 5 rounds thus far, most recently in a $58 million in Series C funding round in January 2015. Investors include Andreessen Horowitz, Richard Branson, Index Ventures, and IA Ventures, etc. Likewise, WorldRemit, headquartered in London and founded in 2010, is an “online money transfer business enabling migrants and expats to send money using a variety of payment options”. This startup received $147.7 million in seven rounds from three investors: Accel Partners, Technology Crossover Ventures, and Project A Ventures. It most recently garnered $100 million in Series B funding in February of this year.

Mobile Payments: Stripe is the success story in this space: “a set of unified APIs and tools that instantly enable businesses to accept and manage online payments.” The company has two acquisitions under its belt and partnerships with Apple Pay, Alibaba, Facebook, and Twitter. It has raised $190 million in 7 rounds – the latest taken place last month – from 18 investors including American Express, Kleiner Perkins Caufield & Byers, Sequoia Capital, Founders Fund, and Visa. Boku (founded in 2009) is another heavy hitter in mobile online payments and based in San Francisco. This startup has completed 4 acquisitions and earned $73 million in 5 rounds from 10 investors: New Enterprise Associates, Andreessen Horowitz, Benchmark, Index Ventures, for example. Lastly, another opportunity in this arena presents itself across the Atlantic: Azimo is a “payment processing company providing internet and mobile based inter-country consumer money transfer services”. Headquartered in London and founded in 2012, the company most recently secured $20 million in Series B funding this past June, contributing to a total of $21.6 million from 4 rounds and eleven investors: Greycroft Partners, Frog Capital, Anthemis Group, and TA Ventures, for example.

Peer to Peer Lending: Public market investors know Lending Club and OnDeck, both of which IPO’ed in December 2014. But there are other opportunities in the pipeline attracting big VC players. For example, Index Ventures, Accel Partners, DST Global and BlackRock among others have invested an aggregate $273.2 million in Funding Circle (founded in 2009, London): “an online marketplace allowing individuals to lend money directly to small and medium-sized businesses in the UK”. Earnest (2013, San Francisco), “a merit based lender” received $32 million in two rounds – most recently $17 million in Series A funding in January 2015 – from Maveron, Andreessen Horowitz, and Atlas Venture, etc. Lastly, Prosper (2006, San Francisco) – another peer to peer lending marketplace already acquired a company and received a whopping $354.9 million in 12 rounds from 26 investors.These investors include venture capital funds like Accel Partners, Benchmark, Dag Ventures, Sequoia Capital and financial services companies, such as BlackRock, Credit Suisse, BBVA Ventures, Neuberger Berman Group, SunTrust Bank, and USAA.  This startup’s most recent funding round occurred in April of this year.

Personal Finance: Startups under this category range from helping people save money to accessing credit scores more cheaply. Expensify, founded in 2008 based in San Francisco, offers “an online expense management service for customers worldwide”. VC funds, including Redpoint Ventures, SV Angel, and OpenView Venture Partners have invested $27.2 million thus far, including $17 million in July 2015. Credit Karma (founded in 2007, San Francisco) provides “free access to credit reports and scores, personalized financial recommendations and educational resources”. This firm just raised $175 million in Series D funding in June, adding to its grand total of $368 million in 6 rounds from 12 investors: Tiger Global Management, Google Capital, Ribbit Capital, and 500 Startups, for example.

Cryptocurrency: There are a slew of fintech startups involved in cryptocurrency, or bitcoin in particular, but we’ll just highlight a couple. Payment processor for Bitcoin, BitPay (founded in 2011, Atlanta) raised $32.5 million in 3 rounds and 16 investors thus far, including Index Ventures, Founders Fund, and Richard Branson. Another example, Coinbase (2012, San Francisco), enables “any consumer to create a Bitcoin wallet and start buying/selling Bitcoin instantly by connecting their bank account”. This startup has completed two acquisitions and raised $106.7 million in total from 4 rounds and 21 investors; it received $75 million during its most recent round in January 2015. Investors include Andreessen Horowitz, BBVA Ventures, Ribbit Capital, and Y Combinator.

Trading & Robo Advisers: The advent of automated financial advisers is nothing new, but still serves as a notable example of startups encroaching on an industry by scooping up business at the low-end – straight out of Harvard Professor Clayton Christensen’s “Innovator’s Dilemma”. Wealthfront, for example, received $129.5 million in 5 rounds from 33 investors since it was founded in 2011 (headquartered in Palo Alto). Some investors include Index Ventures, DAG Ventures, Spark Capital, and Greylock Partners. Another interesting take on disrupting this space is the startup Robinhood: “a commission-free, mobile-first stock brokerage.” This online brokerage recently raised $50 million in Series B funding in May 2015, adding to a total of $66 million from 3 rounds and 20 investors since it was founded in 2013 (Palo Alto). Investors span from VC funds like New Enterprise Associates, Google Ventures, Andreessen Horowitz, and Index Ventures to celebrities, such as Snoop Dogg, Jared Leto, and Nasir Jones.

Student Loans: Huge amounts of money are flowing into startups addressing arguably the largest headwind for millennials: student loans. Sofi (founded in April 2011, San Francisco) has already originated +$2 billion in loans that “help early-stage professionals get ahead including student loan refinancing, low down-payment mortgages, mortgage refinancing, and personal loans.” This firm amassed $766.2 million in 10 rounds from 17 investors, including $200 million in Series D funding this past January. Investors include: Third Point Ventures, Institutional Venture Funds, Discovery Capital, Peter Thiel, and Baseline Ventures. A similar startup, Upstart (2012, Palo Alto), just took in $35 million in Series C Funding last month, adding to a total of $53.2 million from investors including Third Point Ventures, Google Ventures, Kleiner Perkins Caufield & Byers, Mark Cuban, and New Enterprise Associates.

So how are banks responding? Some are partnering or investing in their own fintech startups. For example, Goldman Sachs and JP Morgan are working with online broker Motif Investing. Others, including Barclays, UBS, Citi, Santander, Wells Fargo, Deutsche Bank, and BBVA Compass either support or have launched their own “accelerator programs”, or innovation labs in tech hubs around the world to improve their technological capabilities. How can fintech startups and banks really get along? One such synergy is the partnership between OnDeck and BBVA Compass, in which the subsidiary of Banco Bilbao Vizcaya Argentaria earns a referral fee by sending small-business customers who don’t fit their loan requirements to the online lender.

JPMorgan Chase CEO Jamie Dimon understands the crossroads that banks face. He addressed the challenge of competing with startups in areas, such as lending and payments, given their efficiency in his latest annual letter to shareholders. His takeaway: partner where it makes sense and learn from competitors to develop their own strategies. Either way, in Mr. Dimon’s own words to Wall Street: “Silicon Valley is coming”. Read full post on Convergex.com. 

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7 and a half ‘Good Reasons to Buy a Bad Company’

Originally posted on Convergex.com

Summary: All the good ones are taken.  After six-plus years of a bull market in U.S. stocks, great companies tend to have equally great valuations and wide followings.  What’s left – the names that aren’t working – are cheap for a reason.  Or many reasons.  Yet in that slurry must be some gems.  Today we consider a checklist of potential investment catalysts to help separate the genuine turnarounds from the stuck-in-the-muds.  High on the list: new management, anticipated breakups/spinoffs, and industry-wide rationalization. Low on the list – and with a cautious bias – is the presence of an activist investor demanding only stock repurchases.  And one reason that should never be the sole basis to buy the stock of a troubled company: valuation

There are some 53 companies in the S&P 500 that are down more than 20% over the last year even as the market as whole is up 7.2%. Just over half of them are in the Basic Materials sector, which includes many energy names.  Easy enough to understand how they ended up in the dog house – the sharp decline of oil prices late last year dramatically reshaped the earnings profile of these companies.  The second largest group of red-numbered stocks belong to Industrial names that by and large service the energy sector.  After that come a series of one-off stories in the Consumer and Tech spaces. Makers of fashion-sensitive accessories or high-priced coffee machines, for example.

What’s remarkable about this list is just how many “Good businesses” are passing along lousy returns to their investors.  No one doubts that “Big Oil” or manufacturing large and complex earthmoving equipment are fundamentally decent businesses over a cycle.  Selling popular, if perhaps slightly overpriced, handbags has rarely driven business owners to the poor house.  There’s even a well-known casino operator down +45% over the past year.  No one has rescinded the law that says “House always wins”.

There are big differences between a bad stock and a bad company.  The former is often a function of an unforeseen macro event combined with valuations that become stretched on the up cycle and then break as investor euphoria diminishes.  Casinos are a good business, but the Chinese casino business has some challenges just now.  Oil is a good business, unless you view the world solely through the eyes of a conservationist, but a 50% decline in oil prices is going to hurt even the largest and lowest cost producers in the near term.  “Bad companies”, by contrast, lose money over a cycle or, best case, make too little in the way of returns on capital to compensate their owners for their investment.

“Good industry/company” and “profitable sector/stock to own” don’t have to be the same thing either.  I covered the auto industry from 1991 to 2003, as both a brokerage analyst and portfolio manager, so I know a bit about lousy industries and the companies that inhabit those rabbit holes.  I mention that mostly because Sergio Marchionne, the current CEO of Fiat Chrysler, recently gave a presentation entitled “Confessions of a Capital Junkie” where he outlined just how bad a business the global auto industry has become.  Spoiler alert: it’s been bad since the 1980s. Overcapacity and rising capital requirements have been the crumbling cornerstones of the industry since Honda opened its first auto assembly plant in America in 1982 and GM decided to counter with its Saturn small car operation just three years later.  Hope springs eternal in the auto industry, even if decent profits seldom follow.

And yet, there has been good money to be made over the years in auto stocks. Ford Motor Company, for example, bottomed in late 2008 at less than $1.50/share. It now trades for close to $15. American Axle troughed at $0.70 about the same time as Ford, and closed today at $20.70. Even after a pullback from $26 earlier this year, that’s an obviously outstanding return. You can actually make very good money in a very bad sector.

Now, there’s obviously a method to the madness of finding these outsized returns.  Here’s a cheat sheet for finding the intersection of “Bad company” and “winning idea”:

Cyclical Upturn.  That’s the magic behind the historical returns at Ford and Magna, of course.  Car sales have improved by +50% from the cyclical lows of the Financial Crisis and that helped first assure ongoing viability and then boost earnings and cash flows.  In practical terms, this is the easiest intersection of “Lousy industry” and “big returns”.  The global energy industry is shaping up to be this year’s big cyclical trade.  You’ll just need a strong stomach to load up at the right time, because it truly is darkest before the dawn.

New Management.  Going back to the early 1990s but staying in the auto industry, Goodyear Tire was one of the big winners of the 1990s automotive cycle because the company’s Board brought in Stanley Gault to run the place after a brush with bankruptcy in mid-1991.  Gault had turned around Rubbermaid in the 1980s, and dramatically expanded Goodyear’s retail footprint by selling through Wal-Mart, Sears and other third party retailers. That incremental demand, plus the turn in the U.S. economic cycle, took the stock from $8 in 1990 to $75 in 1998.

Industry Rationalization.  If there was a worse structured sector than making new cars and trucks from the 1980s to 2009, it was likely the airline industry.  Old timers will recall the usual cadence of earnings estimates for any company in the sector as ranging from a loss of $10/share in year one, breakeven in year two, and making $20/share at the top of the cycle in year 3.  Now, with industry rationalization finally complete – at least for U.S. carries – United Continental has gone from $3 in June 2009 to $56 today.  Flying may be a miserable experience, but at least all those full flights show that industry rationalization has finally worked.

Breakup/Spinoff.  In most “Bad companies” there are still “good” operations.  Even the auto companies have their jewels in the form of pickup truck businesses that generate virtually all the profits in many years.  Now, GM can’t sell off GMC truck assembly, but troubled companies can improve their value by selling underperforming operations.  The big trick here as an investor: look to see where the management goes in a breakup or spinoff.  They know more about the opportunities in each business than you. 

Bad Company as Acquisition Target.  Animal lovers know the saying “There are no bad dogs, just bad owners.”  The same is true for companies.  For years I covered a large tire and battery distributor based in Memphis.  They had serious economies of scale, for they controlled 6% of the market for replacement tires in the U.S. and had a million square foot warehouse to show for their efforts.  But selling low end private brand tires is a tough business.  Pricing power?  No.  Unit volume growth?  Not so much. They ended up selling to a foreign tire maker anxious to gain market share in the U.S. for roughly twice the current share price, as I recall.

Fixing the Balance Sheet.  Sometimes it’s not really the company that is “Bad”, but rather the company’s mix of debt and equity financing.  Yes, corporate finance theory says this isn’t supposed to matter.  But sometimes it does, as when the debt burden calls into question the sustainability of the business through a cycle.  Or when the company needs fresh financing to take advantage of acquisition opportunities.  In those cases, redeploying all available operating cash to debt paydown, plus asset sales to give that repayment a further boost, is an excellent way to solve the problem quickly.

(Very Rare) Bankruptcy/Workout Opportunities.  Never doubt that the automotive industry, broadly defined, is a one-stop shop for every single “Troubled company becomes great investment story” you’ll ever need.  In June 2003, AMERCO files for Chapter 11 bankruptcy.  AMERCO owns U-Haul, the self-moving business.  Because one family owned the majority of the stock, they had a strong incentive to retain some equity value even through bankruptcy.  The reorganization worked, and the stock went from $4, split adjusted, to just over $329 today.  Even famed investor Wilbur Ross didn’t think the stock would be worth anything substantive.  Quoted in a 2003 New York Times article about the company CEO talking up AMERCO’s stock to investors, Mr. Ross said “It does seem to me that flogging his stock is not the best use of his time”. And... Activists Getting Involved (Sometimes).  Make no mistake – a good activist is worth 1,000 brokerage “Buy” recommendations, especially when they have a proven track record and a serious game plan for their involvement.  Where things are less clear is when they invest in a bad business and then ask for only share repurchases.  I have seen numerous iterations of this in the auto industry.  Over the last 20 years activist investors have pushed automakers to buy back their stock when the cycle was running hot and these companies were making good profits.  The trouble with that is, of course, that they run short of money when the cycle turns down.  Would GM and Chrysler have had to file Chapter 11 in 2009 if they had stored up their cash in the 1990s and 2000s?

We’ll close out with one reason that never seems to work when it comes to buying “Bad” companies: valuation. At first blush, it would seem that simply buying a poor performer for a steep discount to its peers should give enough room for error that more often than not you’ll get a decent return. Yet without some catalyst, such as the ones we’ve listed here, it is too easy to end up in a value trap.  No – bad company/sector investing requires more than simple valuation math to generate reasonable returns.  It needs a roadmap, which itself is a good reminder of the “Good company/bad investment” conundrum.  Rand-McNally, famous maker of maps and atlases, was sold in a prepackaged bankruptcy deal in 2003 after taking on too much debt as part of an LBO and then falling behind to more tech-savvy competitors.

You really have to keep your eyes on the road… Originally posted on Convergex.com 

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3 Key Observations on Last Week’s Money Flows of US listed ETFs

Originally posted on Convergex.com

Summary: Whenever we see notable bout of asset price volatility such as last week’s manic seesaw, we wonder where investors are putting fresh money to work.  Are they running for the hills, or doubling down? The last few days have been pretty spicy, so today we look at one week money flows into/out of U.S. listed exchange traded funds.  Three points pop out of the analysis.  First, essentially all the net inflows of the last week – some $16.3 billion – went to U.S. equities ($16.0 billion). Those are big numbers for ETF land: 13% of the 2015’s total inflows came during just 4% of the year thus far. Second, leveraged/inversed ETF product usage popped, with $1.1 billion of fresh money last week (20% of all the flows for the year). Lastly, fixed income flows signal little real concern about the near/medium term direction of interest rates.  In the last week, $1.3 billion went into bond ETFs, about on pace with the rest of the year’s cadence.  One bonus thought: ETF sponsors should consider stock splits, as some individual companies are now doing.  Of the top 10 ETF destinations for fresh cash in 2015, the average trading price is $65. For the top 10 ETFs by assets, that average is almost double, at $120/share. Want to grow?  Keep your prices low…

Over most of the last six years, since the March 2009 lows for the S&P 500 really, periods of volatile market action have been relatively rare.  The last week is therefore a good chance to see what investors do when markets get snarled in a sideways churn.  Do they give up and sell/go back home?  Or do they forge ahead, confident that their end destination is worth the wait?

Looking at the money flow data for U.S. listed exchange traded funds is one way to assess this question.  It’s not perfect, since money added to ETFs might be used to create more shares to short, allowing traders to bet on a price decline.  Given the wide range of investors that use these products – everyone from small balance retail to the largest institutions – you can, however, get a sense of where the money is going.  And, more importantly, how fast it is getting there.  We use www.xtf.com as our data source for the following analysis.

3 Key Observations A look at the 1 week money flow data for last week’s choppy market action (not including today’s snapback) yields 3 key observations:

Money flows are resoundingly positive and largely aimed at U.S. equities.  Over the last week, U.S. listed ETFs saw $16.3 billion in inflows.  By way of context, year to date money flows are $121.5 billion. That means 13% of all the fresh money into U.S. ETFs this year came in just 4% of the time since the calendar turned to 2015. Moreover, despite all the volatility in U.S. stocks last week, virtually all the net inflows ended up in this asset class: 98% of it, or $16.0 billion. The largest inflows went to S&P 500 stocks, the large cap financials sector, and small cap equities.  No surprise, but outflows were focused on European and Asian equities as well as emerging markets.

That’s not to say that investors and traders who use ETFs ignored the volatility – far from it, in fact. There are 258 ETFs that xtf.com categorizes as “Leveraged”, “Inverse” and “Inverse Leverage” and last week ETF traders added $1.0 billion of new money to the “Leveraged” basket.  That amounts to a third of all the fresh capital applied to this group for 2015 as a whole, all in just the last week.  The big winners in terms of asset flows were in the energy sector (oil and natural gas prices), small cap/tech stocks, and Chinese equities.

If the Federal Reserve is still trying to signal its desire for higher long term interest rates, the message is not getting through to ETF investors.  Last week, even as Fed Chair Janet Yellen reiterated her goal of moving on Fed Funds by the end of the year, ETF investors plunked in $1.3 billion into fixed income products.  Just over half - $752 million – went to U.S. bond funds ranging from short term (1 – 3 year Treasuries) to high yield corporates.  While these sums may not impress compared to the equity flow numbers, they are spot-on average for the year, with $26.6 billion of new money coming into bond ETFs in 2015 to date, of which $19.6 billion is U.S. paper.

Culling through the data, we also found one interesting anomaly: the 10 funds with the largest year-to-date positive money flows – some $56.7 billion, or 47% of all that fresh cash into U.S. listed ETFs this year – tend to have lower share prices than the largest ETFs in the business.  These top asset-gatherers have an average price of $65/share, versus $120/share for the 10 largest ETFs in terms of total assets under management.  Looking through the 2 “Top 10” lists, it is easy to see why.  Of the largest ETFs by total assets, you have 2 that are over $200/share (SPY and IVV), and 5 that are over $100/share (VTI, QQQ, VOO, IWM, and IWF).  Move over to the top asset gathering funds for 2015, and only two are over $100/share: VTI and VOO.

As with individual companies, simple corporate finance theory tells you that the price of a stock or ETF is irrelevant to its ultimate “Value”.  However, many retail investors do still like the notion of buying a round lot of a 100 shares, and the ETFs with lower prices do seem to have gathered more in new assets this year than the largest funds.  ETF sponsors should likely do the same analysis that many large corporations regularly consider: “Should we split our stock?”  Conversely, those considering adding new products to compete against existing funds should think about offering a more “Affordable” alternative if the competition’s price is +$100.

Back to traffic jams and money flows for one final thought.  The volatility of the last week does not seem to have hurt investor confidence in U.S. equities – the numbers show that clearly enough.  At the same time, we should put that churn in context: last week, the CBOE VIX never even closed over 20, its long run average since 1990. It was just enough concern to pull money back into domestic equities, but not enough to spook investors out of stocks entirely.  In traffic terms, last week was a short rubbernecking delay related to the accident over in Europe.  Once past that fender-bender, everyone sped up again. Originally posted on Convergex.com

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The Ongoing Greek Debt Crisis: What will it take for some dramatic change?

Originally posted on Convergex.com.

Summary: The Trojan War lasted 10 years, and the Peloponnesian War almost thirty; in that context, it should be no surprise that the long-lived Greek debt crisis continues to unfold.  The big question now is “What will it take to get some dramatic change – what ancient dramatists called catharsis – to end the current round of negotiations?”  To answer that we turn to Aristotle, the philosopher who literally wrote the book on the proper structure of drama.  His guidelines for good storytelling are useful milestones as we continue to plod along with the overhang of Grexit/Grexodus/whatever cutesy phrase is making the rounds. Good drama needs three things to be complete: unity of action (no subplots), unity of time (ideally 24 hours) and unity of place (don’t jump geographies).  With those guidelines, it is easy to see why the drama continues in such an unpredictable manner. Investors like good storytelling, because it allows for predictable outcomes.  This particular Greek drama, however, needs a major rewrite.

One of the recurring themes in our work is that capital markets work around predictable narrative forms. Humans, and increasingly their robotic counterparts, follow stories rather than trying to reprice every asset, every day, in real time.  Just consider how powerful the “Hero Myth” of one person’s journey has been to the likes of Apple or Tesla’s stock over the last decade. Or think of the power of “Creation Myths” to the anonymously founded Bitcoin with regard to the early success of that online currency or the Hewlett-Packard garage to modern human-capital-rules-all Silicon Valley.

Stories – their structure and the people within them – are the skeleton on which investors hang the muscle and sinew of daily news flow. A well-structured story, such as the power of central banks to drive capital markets, can move asset prices profoundly and over long periods of time. Changing the narrative – something the Federal Reserve is trying to do at the moment – is a tricky business indeed. Something akin to an onstage wardrobe change, it has to be done with a good deal of practice and even then sometimes it still goes awry.

The most dominant story of the week is, of course, the ongoing Greek debt crisis.  This has been a long-brewing problem, with roots in dramatic fiscal mismanagement before the Financial Crisis and weedy flowers blossoming every few summers since then.  The story line here is muddled in an unproductive mixture of politics, economics, demographics and social stereotypes, not to mention two large scale wars over the last 100 years. That all has proven to be a potent recipe for market volatility, since there is no consistent narrative for investors to follow. Who’s really in charge (who is the ‘Hero’)?  What is the ultimate goal of this “Journey”?

The only constant in life is change, as the old saying goes, but we as investors need a roadmap to assess if the world at large is heading in the right direction. In theatrical terms, are we moving the plot along?  Where is the climax of the action? When will the main character – whoever that is - undergo the change that the ancients called “Catharsis”?

That term – a dramatic and emotional change in character that creates renewal and the chance for a better life - comes from the Greek philosopher Aristotle. Given the locus of the recent crisis on his home field, I thought it would be useful to review his take on what makes for a good story. Old Aristotle would have been a great stock market analyst, or perhaps a writer at Buzzfeed, because he liked to make lists. Lots of them.  In the case of his “Poetics”, he enumerates the 3 key points for a good dramatic plot. They have been reworked by critics through the ages, but essentially they are:

Unity of Action:  Have one plotline, and keep it moving.

Unity of Time: The action should take place over a set timeframe, ideally 24 hours.

Unity of Place: The play should take place in one location.

These lessons still work well today. Just consider the success of hit TV shows like “24”, which held to the “Unity of Time”, each season taking 24 hours to complete. Or the 7 Oscar-award winning movie “Gravity”, with its cohesive storyline taking place largely in one location.  Comedy – think “Seinfeld”, with its multiple plotlines – doesn’t need to hold to the rules of drama. But to really hold an audience’s attention and create an emotional bond, Aristotle’s rules are still a good starting point.

Against this backdrop, it becomes easier to see why capital markets are in for a confusing week and maybe longer. Following Aristotle’s maxims, here is why:

No Unity of Action. This weekend’s European Financial Ministers meeting highlighted that there are many subplots afoot in the currency crisis. Countries from Finland to Germany to France have their own internal political agendas that deeply color their perspective on another Greek bailout.   In addition, the dominant theme this weekend was one of “Trust” – can the Greeks be trusted to follow through on promises now, when in the past they have failed to do so?  While trust may be a universal human trait, it is also a distinctly egocentric one.  Everyone likes to think they are trustworthy and prior mistakes should be forgiven.  Similarly, trust is an easy thing to lose and a hard one to rebuild. What is “Fair” – another emotional aspect of the current crisis - for the Greek people was the keystone of the recent referendum, and again that is a distinctly asymmetrical calculus.  People of all nationalities tend to think of themselves as fair-minded… The bottom line is that the Eurozone is currently negotiating more like a dysfunctional couple in marriage counseling than the world’s largest economic bloc of sovereign nations. Emotions are running high, but in ways that would make for a disjointed and hard to understand theatrical narrative.

No Unity of Time. Some progress on this one, at least as of Sunday afternoon.   There is some talk of forcing the Greek Parliament to pass a series of reforms by Wednesday, including VAT reform and a lockbox for the eventual proceeds of the sale of state assets. There is also the problem of the Greek banking system, which is essentially out of money. Still, it’s hard to shrug off the notion that we’ve been here before and there is no hard-and-fast endpoint to the current round of negotiations.   

No Unity of Place. As with the first point, the Greek debt crisis has no firm location. Germany may be the largest lender and Greece the problematic borrower, but there are 26 other countries in the mix. How often do you see pictures of some combination of Angela Merkel, Christine Lagarde, Francois Hollande, and countless other officials in conference with Greek Prime Minister Alexis Tsipras? The action in this drama moves from Athens to Brussels to Berlin and other capital cities so often that Aristotle would pull his hair in frustration.  Capital markets feel the same way.

Now, it’s fair to say that the Eurozone was never going to be Aristotle’s idea of a great piece of theater. Too many locations, too many plotlines, too many everything for his liking. And under ordinary circumstances, that level of diffusion is fine. It is the current situation, fraught with risk, which needs a clear storyline in order for markets to discount its outcome. When we have unity of time, place and action, then we will know we are near a solution.  Not before.  

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The Russell Rebalance 2015: the busiest trading day of the year?

Today will almost certainly be the busiest trading day of the year, as the Russell indexes go through their annual rebalancing/reconstitution. But Friday’s close will be the end of a trade that began almost 2 months ago, as traders began handicapping which equities would be included for the first time or swapped between various Russell indices. Since the beginning of May, for example, the stocks that will be added to the Russell 2000 are up 11%, and those being deleted from the same index are down 2% over the same time period.  Today’s trading will likely see those trends continue, with as much as half the total day’s volume concentrated in the last 5 minutes of the day.  Also look for names swapping between the widely followed Russell 2000 and the less-commonly tracked Russell 1000 to have some one-day volatility.  In short, for one day – and this is the day - every U.S. equity market participant, no matter what their investment mandate, needs to think like a trader.  Throw in a little Greek drama going into the weekend, and it could be quite a day… Read our full commentary on The Russell Rebalance here. 

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Will the DJIA hit 20,000 or 16,000 first?

Summary: The Dow Jones Industrial Average is up 324 points for the year to date – some 1.8%.  And despite there being 30 companies in this oldest of all broad market measures, just 2 names make up all that performance (and then some, actually).  Goldman Sachs is up 12% year to date, adding 174 points to the Dow and UnitedHealth’s 21% return is worth another 164.  You’d think it would be the other way around, but GS’s higher stock price gives it a heftier weighting. Yes, the other 28 names in the Dow net out to zero impact for the year. That includes Apple, which has actually cost the Dow 14 points since its much-anticipated addition back in March. So what will get the Dow to 20,000 or 16,000?  It’s pretty simple either way: ten companies make up half the Dow Jones Average by weight: Goldman, IBM, 3M, Boeing, Apple, UnitedHealth, United Technologies, Disney, Home Depot and Nike.  Any bull or bear story for the Dow – and by extension the U.S. equity market as a whole – runs through those 10 names. Read the full analysis here.  [Originally posted 6/23/2015]

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How much does the “Crisis” in Greece resonate with American consumers?

By Nick Colas // Originally posted on Convergex

Summary: Greece may be in the headlines, but how much does the “Crisis” there resonate with American consumers?  Using Google Trends to assess various economic-related searches, the answer seems to be “Not much”.  Users in the U.S., for example, are +10x more interested in “Jobs” as a search term than “Greece”.  “Uber” is 2x more likely to be the subject of a search than the nation of the Hellenes, and Apple-slayer Taylor Swift gets three times the number of Greece-related searches.  The same goes in Germany, by the way: “Mercedes” and “VW” both outpace “Griechenland” by almost 2:1 for Google searches.  And has the recent drumbeat of new highs sparked a renewed (and perhaps bubbly) interest in U.S. equities?  Again, using Google Trend, we find the answer is “Not even a little”.  “Buy stocks” doesn’t even get the same traffic as “buy gold”, and the yellow metal hasn’t seen a new high since 2011. When I go out to eat at a restaurant, I like to people watch.  Nothing unusual in that, I suppose, but my favorite pastime to make up stories about my fellow diners – the more fantastic the better.  A few examples:

A large table populated by people of wildly different ages isn’t a heart-warming family dinner; rather, it is the celebration party for a Little League game-fixing operation after a contest where the losing team didn’t quite cover the spread.

Two young men holding hands isn’t a new couple; instead, it is a pair of straight rookie policemen who drew the (very) short straw and have to blend into a Hell’s Kitchen hot spot while tailing a drug dealer/white slaver.

Even the typical sullen middle aged couple – a virtual fixture in any Manhattan eatery with more than one star – isn’t just a marriage on the rocks.  No… The man is trying to explain why he never told his wife about his stint in the French Foreign Legion or the origin of that faded blue prison-ink scorpion tattoo.

This exercise has its place in capital markets “Restaurant” at the moment, because Greece seems to be at every table.  How did it get there, and what’s its fake-real story? It is easy to see why global investors have a passing interest in this country of 11 million people, but what about the average American consumer? Yes, all +300 million of them. Or, put in econo-speak, “Does the ongoing turmoil surrounding the Greek debt crisis make Americans more uncertain about their economic future?”

To get an answer, we turn to Google Trends, an online tool that allows you to see how many users search for a given term over time.  Given the search company’s still dominant share of Internet searches, it seems a reasonable proxy for consumer attention. Here is what the data reveals:

Searches for “Greece” among U.S. Google users are no higher than before the Financial Crisis (pre-2007).  Yes, they spike a bit in 2010 and again in June 2014, but overall interest is flat from the mid-2000s to now. Not surprisingly, the searches come from New York State (and it’s not New York - there is an upstate town with a population of 96,000 of the same name), Massachusetts, and New Jersey.

Online searches that include the word “Jobs” are currently +10x more common than queries over Greece.  The average difference over the past year is more like 20x.  In other words, American consumers think a lot more locally – and personally – than globally. Top states for “Jobs” searches: North Carolina, Texas and Maryland.  Top cities: San Antonio, New York, and Washington D.C.

To see where Greece fares relative to a really hot business story, we used Google Trends to evaluate search counts for “Uber”, the hottest of all startups, versus “Greece”.  The car sharing service kills it for consumer attention, with just over a 2:1 ratio of searches over the troubled European country. Hot states for Uber searches: D.C., California, Hawaii, New York, and Massachusetts.

The word for Greece in German is “Griechenland” (yep, we Googled that), so we can use Trends to evaluate German consumer interest in the country versus other popular search terms.  We chose “Mercedes” and “VW”, and sure enough they outpace interest in Greece by 83% - almost a 2:1 difference. One point in Greece’s favor over the automotive companies – search interest is rising quickly through mid-June and closing in on a prior peak.

With American pop star Taylor Swift in the headlines today over her dustup with Apple, I couldn’t help but bring her into the analysis.  First, a piece of trivia: what three states top the charts for relentlessly searching for anything and everything Swiftian?  Answer: Pennsylvania, Tennessee, and Utah. Yeah – I don’t know why either.  But I do know that she draws 3x the number of searches as Greece. One person versus a whole country, and the country loses.

With the Google Trends screen open, I also got to wondering if Americans were any more interested in “Buy stocks” with the equity markets grinding to new highs for the Russell 2000 and NASDAQ today.  For a comparison point, I entered “Buy gold”. I thought it wouldn’t be a fair fight – gold hasn’t made new highs since 2011 – but worth a look.  The results:

It’s not a fair fight, but only because “Buy gold” is consistently a more popular search term than “buy stocks”, going all the way back to 2005.  Searches for stocks did spike higher than gold in October 2008 and March 2009 (who says retail can’t call a bottom?), but average interest in the yellow metal runs 30-50% higher than equities over the last decade.

Top states for gold searches: Nevada, New Jersey, Florida, Arizona, and Texas.  Top cities: Las Vegas, Phoenix, Houston, Tampa and New York.

Top states for stock searches: New Jersey, North Dakota, Delaware, and Pennsylvania.  Top cities: New York, Houston, San Jose (CA), Los Angeles and Tampa.

The upshot of these two brief analyses is a bit of an odd pairing, very much like fodder for my little game of Funny Story Restaurant Bingo.  On one side of the table, you have American (and German) consumers that seem unfazed by all the supposed drama over the Greek debt bailout.  They care much more about jobs, or interesting startups, or even Taylor Swift. On the other side, you have a clear lack of social attention on equity markets.  Up a little, down a little, new highs…  Nothing seems to generate much incremental attention.

If you are of the mind that bubbles require outsized societal attention before they reach truly dangerous proportions, this is good news for you.  We’ll tread more cautiously on that ground, if only to see if there is a juicier story to tell.    

Read more on Convergex.com 

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How the Last Month’s Capital Markets Volatility has Flowed Through US listed ETF Ecosystem

Originally posted on Convergex.com.

Summary: Today we take a brief look at how the last month’s capital markets volatility has flowed through the U.S. listed exchange traded fund ecosystem. Given the back up in global interest rates, for example, you won’t be surprised to hear that fixed income ETF flows are negative $2.8 billion over the last month even though they still show $22 billion in inflows for the year as a whole. The big winners are equity products over the last 30 days, with $19.6 billion in fresh money.  Surprisingly, this rising tide has been enough to shove U.S. equity flows into some semblance of forward motion.  Over the last month domestic equity ETFs are up $5.2 billion in new capital, even though you can color those money flows red to the tune of $17.5 billion for the year to date. The big lesson here: money may be starting to leave fixed income assets, and its next destination will tell us the direction of equity markets.  And we have one suggestion for ETFs that want to gain market share in this increasing competitive landscape: think about splitting your stock.  Of the top 10 U.S. listed ETFs in terms of assets, 7 of them have a price greater than $100. Among the top asset gathering ETFs of 2015, only 2 are prices over $100. Why should Netflix have all the fun? 

In the spirit of a quick “Feel Good Friday” story, let’s chat for a minute about how musicians create their art. One of my favorite stories involves an Amy Winehouse song: “Tears Dry on their Own”. Its classic Amy:  there’s an old school feel to the music for which she was well known and the lyrics - which she wrote – are clearly by a woman who has seen her share of romantic disappointment.  But when you search for the artist information online, you are in for a surprise: the words may be Winehouse’s but the music is straight from a 1960s Motown song. “Ain’t No Mountain High Enough” was a hit for Marvin Gaye and Tammi Terrell in 1967, written for them by songwriting greats (and married couple) Nick Ashford and Valerie Simpson.  And 40 years later, almost to the day, it became an Amy Winehouse song.  “Ain’t no mountain high, ain’t no valley low, ain’t no river wide enough” in 1967 morphed into “All I can ever be to you is a darkness that we knew, and this regret I got accustomed to” in 2007. The story I read most often is that Winehouse was fond of karaoke recordings – records, CDs and computer files with the voices removed from popular songs.  She heard the Ashford & Simpson song one day, liked it, and put her lyrics over it. The title of this note, by the way, is obviously from Amy’s version… This feat of musical recycling brings us to the financial topic of day: how does capital cycle through the markets, and who writes that tune?  Is it the crisp Motown love song or the fog of Marlboro Lights and Chanel #5 we notice first?  To work that out, we’ll take the remainder of this note to describe what’s been happening in U.S. listed exchange traded fund flows over the last month and for the year to date.We rely on the data from www. xtf.com for much of this analysis, and here are our 5 most notable points:

The U.S. listed ETF industry continues to grow at a very healthy clip, outstripping the asset growth in mutual funds year to date. There are now 1,726 exchange traded products trading, with $2,151 billion in assets under management.  A total of 105 new funds have launched this year, and 41 delisted.  Total assets are up $147 billion for the year to date (as of yesterday), and of that $92.3 billion are fresh inflows.  By comparison, U.S. listed mutual funds are up $82 billion in fresh assets through June 3rd, according to the Investment Company Institute.  

Since much of the volatility in capital markets this year has centered in the global bond markets, let’s start by looking at fixed income ETFs.  In terms of assets, they are a small part of the U.S. exchange traded fund ecosystem at just $311 billon of the previously mentioned $2.2 trillion in AUM.  Still, in the first quarter of 2015 they managed to gather $19.4 billion in new money.  This quarter has not been as kind. Over the last month, fixed income ETFs are down $2.0 billion in money flows out of these products.  The bulk of this outflow - $1.6 billion – came from U.S. bond funds.

If the churn in global bond markets has spooked equity investors, the world of U.S. ETFs isn’t especially frightened.  One month flows are positive to the tune of $19.6 billion, and for the quarter-to-date that result rises to $32.6 billion. These aren’t just decent numbers - $20 billion in a month is downright impressive.  Just consider that U.S. equity ETFs have had a tough time gathering assets this year; the YTD flow number is negative to the tune of $17.5 billion, as investors moved capital offshore to (hopefully) benefit from central bank policies in Europe and Asia.  And yet…  One month trailing capital flows into domestic equity ETFs are positive $5.2 billion.  Maybe investor perceptions of U.S. equities are turning more positive, even with the Federal Reserve (probably, maybe…) about to raise interest rates. 

Other smaller segments of the ETF ecosystem are also seeing volatile fund flows.  Commodity funds, for example, are down $750 million over the last month and $1.9 billion in the quarter-to-date.  Their total AUM amounts to $61 billion, so these are meaningful numbers.  Volatility funds are, oddly, not gather much in the way of assets over the last (volatile) month.  On a base of $2.9 billion, they saw redemptions of $6.8 million over the last month.  Year to date, the numbers are much better: an additional $838 million in fresh assets. 

The upshot of all this is straightforward: for the moment, the volatility in fixed income markets is pushing the marginal investment dollar into equity products. It’s not that investors are fleeing bond ETFs.  The more accurate portrayal is simply that equities – even U.S. stocks – are at the top of the “Fresh money buy list”.  Now, this could change in the coming weeks if higher yields begin to noticeably slow the global economy or begin to pull assets back to their newly higher yields. 

This is the tug-of-war to watch between now and the end of the second quarter of 2015: higher global yields versus higher equity prices.  The evidence from U.S. ETFs so far is that equities are winning.  So it’s the cheery “Ain’t No Mountain High Enough” for now.  But that’s OK – we have the Amy Winehouse track cued up if we ever need it.   Originally posted on Convergex.com. 

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Asset Price Correlations for Equities, Fixed Income, Currencies and Commodities [June Update]

Summary: We’ve got some good news, and we’ve got some bad…  The latter is pretty obvious from today’s price action for U.S. equities.  Domestic stocks are still fretting about the Federal Reserve’s schedule for a rate increase and the recent volatility in global debt markets. We expect that to continue through the month of June at the very least.  The good news, such as it is, relates to asset price correlations relative to the broad market.  After years of tied-at-the-hip price action, the average industry sector correlation to the S&P 500 is trending lower: 77.7% last month versus 83.8% since 2009.  Even the stickiest industry sector in terms of price action to the S&P 500 – the Financials – are down to an 87.9% correlation versus their post-2009 average of 91.0%. Baby steps there, but moving in the right direction.  The bottom line here is that lower correlations mean that active managers (finally) have an environment in which there is enough variant price action to outperform their benchmarks.  Let’s hope nothing comes along to spoil that trend, because markets also need low correlations to allocate capital properly.   Read Full Analysis HERE >>  

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The Mystery of the Missing American Consumer: Gas Consumption is Up, But Where is Everyone Going?

Summary: We’ve found where Americans are spending their gas savings this year: they are buying more gas because they are driving more.  Miles driven – a monthly metric calculated by the Federal Highway Administration – are up 3.9% year over year for March 2015 (latest data available).  The six month rolling average is now 3.4% higher than last year, the best comp since June 2004 (3.6%), March 1997 (3.8%) and – gulp – June 2000 (4.3%).  Hitting the road means hitting the gas pump first, and gasoline consumption also up, to the tune of 2.8% year over year in March, and 2.6% on average for the last 6 months.  Again, that growth is more consistent with boom times like the 1990s and early 2000s.  So where are we all going?  The easy answer is “To work”, as 86% of Americans commute by car. The long run correlations between job growth and miles driven support that assumption.  The obvious bump in that road is that job growth has been slowing, so we are left with two possibilities. One, the survey-based employment data on which the Federal Reserve makes policy is undercounting actual employment growth.  And that means the Fed is way behind the curve.  And the other – Americans have rediscovered the joy of just cruising.  With no particular place to go. Call it “The Mystery of the Missing American Consumer”.  At the tail end of last year, most economists were dead sure that lower gasoline prices would spark a wave of incremental spending, as most periods of declining energy prices had in the past. Makes sense – less money at the pump means more money to spend elsewhere.  Except this mystery turned into something more akin to the Hound of the Baskervilles, where the central clue was the absence of a barking dog.  As is now painfully obvious, the American consumer took their gas savings, bypassed the mall, and just went home.

Read the full analysis HERE. 

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Are U.S. Equity Investors due for a Retreat?

Summary: If U.S. equities feel brittle, they should.  Even though the S&P 500 is up 2.6% on the year, all that gain has come since early April – Q1 was a washout for large caps with the headwind of a stronger dollar. Valuation of 18x current year earnings means domestic stocks are priced for perfection in a distinctly imperfect world: negative revenue growth for multinational companies, increasingly negative earnings comparisons, and a domestic economy stuck in (at best) first gear. Yes, central bank liquidity from Japan and Europe may well push global equity markets higher.  But what we really need is a pullback – that classic 10% correction that flushes out weak hands, reestablishes the discipline of “Risk” in the “Risk-Return” equation, and shows capital markets how to do more than just follow central bank liquidity.  So watch June’s price action in U.S. stocks very carefully, because this process needs to start now.  The bull market that began in March 2009 is now an ancient bovine indeed.  After all, better 10% now than 20% or more later in the year.  The first is inconvenient.  The second is unwelcomed. Read the full analysis here. 

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CSAs & Research Usage: Webinar Replay

Tim O'Halloran, Co-President of Westminster Research, reviews results from our recent CSA & Research Usage Survey. Overview: There’s been a lot of conversation on the implementation of MIFiD II regulation.  In our world, the conversation focuses specifically on a single section that defines investment research as an impermissible inducement and a conflict of interest – which could change the European financial landscape drastically. In this webinar, Tim offers thoughts and insights along with the opinions of 278 institutional respondents in North America and Europe on what we believe to be the core issues of the debate. Webinar Replay:

For more information and full data deck, visit original post here. 

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Celebrity Endorsements: Do they actually help profitability?

Many multi-billion dollar companies focus their marketing strategies on celebrity endorsements, but does this actually help a firm’s profitability? Nike is one such company partnered with several of the highest profile athletes in the world, and therefore serves as an effective case study when measuring the influence of endorsement deals on firm value. One study evaluated the impact of news related to 30 athletes sponsored by Nike on the company’s share price from 2001 to 2006. The only athlete to significantly and positively impact Nike’s excess returns was Tiger Woods, unlike Derek Jeter, Tom Brady, and Serena Williams for example. What about the potential risk of compromising behavior of an endorser inherent in these deals? In the case of Tiger Woods, another paper published in 2012 found that Nike’s decision to continue sponsoring the golfer after his scandal five years ago resulted in a loss of about $1.4 million in profit for the company’s golf ball division. However, terminating the partnership would have created a $3.5 million or $2.7 million lag on revenue and profit respectively. In fact, the company recovered over half of its $200 million endorsement contract in U.S. golf ball sales alone between 2000 and 2010. But while company investments in professional golfers may prove profitable, selecting a CEO with an above average number of booked tee times often inversely correlates with operating performance and firm values. Read the Full Analysis Here >> 

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The ‘VIX of’ Different Asset Classes and Industry Groups - Monthly Review

For original post, and more content from Convergex, visit our blog.

Summary: Our monthly review of the “VIX of” different asset classes and industry groups finds a broad dichotomy in the market’s expectations of future price risk.  For equities, it’s all good. The expected volatility for everything from U.S. Small Caps to Emerging Markets to 8 of 10 S&P industry sectors is lower over the last month by anywhere from 3-19%.  For bonds and precious metals, the exact opposite is true; options pricing here shows increases in implied volatility of 4-26%. Put another way, the recent backup in interest rates has done little to scare equity investors about either market direction – the S&P 500 is up over 2% in the last month, after all – or the potential for a sudden move lower for equities.  And let’s not forget that the S&P 500 is up 105 points (+5%) since the 10 year Treasury yield bottomed at 1.67% on February 2nd 2015. Closing yield today: 2.25%.  Equities are clearly making the assumption that bonds were simply overbought earlier in the year and the recent rise in rates means, well, nothing.

June is going to feel just a little longer this year. One second longer, to be precise.  On June 30, 2015 the world’s various official timekeeping bodies will insert one extra second at the end of the day.  The reason for the addition is that the Earth’s rotation varies more than the atomic clocks we use to keep “Official” time.  Adding the extra second brings the two back into sync.  Don’t worry – this isn’t like the Y2K fears of 15 years ago.  “Leap seconds” happen frequently (the last one was in 2012) so the world’s computer systems should be able to handle the extra time.

Closer to home, the equity and bond markets have been going through their own slightly out-of-sync gyrations of late.  And it seems to be taking longer than a second to bring them back into harmony.  Consider that:

Very low long term interest rates have been a major boon to equity market valuations since the Financial Crisis, both supporting higher P/E ratios with lower discount rates and making stocks look attractive versus bonds.  Until recently, for example, the yield on the S&P 500 was essentially the same as the 10 year U.S. Treasury note: 1.9%.

Contrary to the old Mae West line, too much of a good thing isn’t necessarily so wonderful and global bond markets clearly got too excited over the possibility of global deflation earlier this year. The 10 year printed a 1.67% yield on February 2nd, for example.  It now sits at 2.25%.  It isn’t economic fundamentals that forced investors to reassess the required rate of return here.  Since early February we’ve had a weak Q1 GDP print, a lackluster start to Q2, weak retail sales, and other disappointments, all largely driven by a U.S. consumer that seems bent on actually saving their “Savings” from lower fuel prices.

And yet… From February 2nd low on the 10 year yield to now, the S&P 500 is up 5%. Part of that is a weaker dollar, to be sure, bolstering the hope that large multinational companies will post better than expected results in the quarters to come.  Fair enough.  Perhaps equity investors were able to see the ultra-low yields in the bond market for what they were – wrong and unsustainable.  In that case they were proven right.  Sometimes you can trade things you know little about far better than your core area of expertise.

Coming back to that leap second for, well, a second…  What closing prices don’t tell you is how much confidence market participants have that they will persist into the future.  An extra second is probably OK.  But how about a month or two… Or a year?

That’s what the options market does.  It takes current asset prices, adds time, and asks traders what they are willing to pay for the chance to buy or sell at different strikes.  In a typical month, assets that rise in price will see lower risk premia imbedded in their option prices.  No one buys flood insurance when skies are clear. And if asset prices are falling (“stormy weather”), investors worry that current trends will persist and they bid up the price of options like the umbrella guy who charges an extra $10 for his last piece of inventory during a deluge.

That’s exactly what happened over the past month, as we show in the accompanying charts.  A few points here:

Very few asset classes saw rising levels of implied volatility in their options chains (a measurement like the CBOE VIX Index, so we just call these measures the “VIX of”…).  The VIX of Investment Grade bonds was up 26% over the last 30 days, no doubt driven by the asset’s 4.1% decline over the same period.  You have to clip a lot of coupons to make up for that kind of hit…  Other inhabitants of the “Volatility Dog House” were high yielding Telecomm stocks (“VIX” here up 26%), High Yield Corporate Bonds (“VIX” up 11%), Gold (“VIX” up 10%) and Silver (“VIX” up 4%).  

For pretty much every other asset class and sector we track, the tide of volatility was very much away from the shoreline. The S&P 500 has been trending higher, of course, and the VIX is 4% lower.  Implied volatility of small cap stocks was 9% lower over the same period, and the “VIX of” mid cap U.S. stocks was 7% lower over the last month.  Eight of the 10 industry sectors showed lower “VIXs”, including Technology stocks (18% lower), Industrials (16%), Materials (16%), Health Care (12%) and Consumer Staples (12%).  EAFE stocks (developed Europe, Asia, Far East) showed a 19% lower “VIX” and Emerging Markets equities “VIX” was 11% lower than last month.

The relationship between the changes in the implied volatility priced into options markets over the month was largely the result of how the various asset groups and industries performed over the period.  The correlation between the two was -68%, a fairly textbook relationship.

To use this analysis to assess current prices, you should consider 2 facts. First, the CBOE VIX Index is hovering around 6 month lows at 12.9. Contrary to the old adage about stocks, you want to buy assets when their “VIX” is high and sell when it is low.  “How low” is always the tricky bit, for the VIX has been below 12 for long stretches.  Second, consider how much longer equity prices can ignore rising interest rates.  Again, equity investors did well not to take the bond rally earlier this year to heart and that clear-eyed realism allowed them to shrug off the recent unwind.  But ultimately interest rates do inform valuations, especially when global growth is still so sluggish.

As you ponder these questions during the remainder of the second quarter, you will have an extra second to consider them. That’s the good news…  The bad news is that markets can turn in a lot less than that one second once they decide rates have gone far enough. We may need that extra second in June very much indeed.   For original post, and more content from Convergex, visit our blog.