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[chrisciovacco]

Radical Shift Brings New Investment Landscape

[chrisciovacco]

Next Bear Market Could Catch Many Off Guard

[chrisciovacco]

Why Is The Fed So Hesitant To Raise Interest Rates?

Stocks and Bonds Both Elevated By Low Rates

Assume you worked hard your entire life and amassed a nice nest egg, allowing you to retire if you could earn an average of 5.00% annually. That plan would not have required you to take a lot of risk when CD rates were above 5.00% in the 1980s and 1990s (see below).

Search For Higher Returns

However, when CD rates started to fall well below 5.00%, you would have been forced to either lower your income expectations or add higher-yielding investments to your retirement portfolio. The search for yield has created additional demand for riskier assets, including stocks.

Higher Rates Reduce Demand For Stocks

For illustrative purposes, if we assume the Fed raised rates back to 5.00% this month, it is easy to understand how many investors would no longer feel the need to invest a portion of their portfolios in higher-volatility assets, such as stocks. Higher rates reduce demand for riskier assets, which in turn can lead to a decline in stock prices. If we knew stocks and CDs would both produce an annual return of 5.00% over the next decade, most would prefer to own the lower volatility asset (CDs).

Bonds Have Benefited As Well

If you invested in a 30-year bond paying over 6.00% in 1999, you would be quite happy with that portion of your portfolio. Fast forward to 2016 when long-term bonds are paying closer to 2.00%. Basic supply and demand tells us most people would rather have a bond paying 6.00% per year than one paying 2.00% per year, which is why bond prices tend to benefit from lower rates. When rates begin to rise, the relative attractiveness of higher paying bonds begins to drop, which is why bond prices tend to fall when the Fed starts to raise rates. The relationship between interest rates and bond prices is based on supply and demand.

Lowering Rates And The Wealth Effect

The wealth effect refers to potential economic benefits created by rising asset prices. When your 401(k) is rising, you feel better about your financial standing. Consumers who feel good about the future tend to spend more, which can be beneficial to the economy. The Fed hopes to stimulate the economy via the wealth effect when they lower interest rates.

Stocks And Bonds Vulnerable To Higher Rates

Rising interest rates can hurt stocks by reducing the demand for riskier assets relative to safer assets. Higher rates can also negatively impact bond prices by reducing the relative attractiveness of higher-yielding bonds that were issued when interest rates were higher. Therefore, stocks and bonds could both sell off if the Fed continues to raise interest rates.

The Wealth Effect Shifts Into Reverse

If higher interest rates put pressure on both stock and bond prices, it stands to reason higher rates can also flip the wealth effect into reverse. When your 401(k) drops, you may not feel as confident to spend and consume as you did when the balance was rising.

Higher Rates Could Spark A Deflationary Spiral In Asset Prices

Last Friday’s plunge in both stocks and bonds provided the Fed with a little reminder of what followed their December 2015 rate hike. The Fed is concerned rate hikes could kick off a difficult to contain deflationary spiral. If asset prices fall, fear increases, causing more investors to hit the sell button…which causes asset prices to fall further and fear to increase…rinse and repeat.

Investors Know Fed Has Juiced Stocks And Bonds

Since central banks have been injecting themselves into the economy and markets with much greater frequency in recent years, investors are well aware of the risks posed by higher interest rates. This knowledge has created a marketplace that has become increasingly skeptical of the Fed’s constant chatter about additional rate hikes. For example, even after numerous Fed speakers talked tough last week on rates, market odds for a September rate hike were still sitting around 24%, meaning the market was saying there was roughly a 76% probability the Fed does not raise rates in September.

How High Are The Risks Of A Bear Market?

In a bear market, stocks tend to make a series of lower highs and lower lows. In a bull market, stocks tend to make a series of higher highs and higher lows. Note in both cases, the stock market pulls back when it makes a low. Therefore, our concerns increase when the odds of a new bear market are escalating. To make sure we are comparing longer-term apples to longer-term apples, this week’s video covers updated charts from longer-term outlooks outlined on August 20 and September 2. The video also reviews historical cases when volatility followed a bullish breakout from a long-term consolidation box, similar to what recently occurred in all three major U.S. stock indexes. Reviewing facts regarding longer-term bullish probabilities relative to longer-term bearish probabilities allows us to assess the odds of an ongoing bull market relative to the odds of a new bear market.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Low Rates And Excessive Debt

When companies and governments can borrow money for next to nothing, it creates additional incentive to issue more debt. As noted above, rising rates can put pressure on debt instruments. The relationship between global debt, the Fed, and interest rates was outlined in detail in Debt’s Impact On Central Banks, Stocks, Bonds, And Gold.

[mitchzacks]

Small Caps - Wisdom or Wasted Opportunity in an Aging Bull Market?

There’s “conventional wisdom” out there that as a bull market matures, large cap stocks tend to become the out-performers. According to this thinking, investors tend to shift investments to companies with well-established revenue sources, market penetration, and huge stockpiles of cash as a bull market ages. In theory, and for the most part in practice, these are the companies better suited to weather an economic downturn.

This means that small caps tend to get slighted in the late stages of a bull, but I think there are some circumstances in the current environment that argue for the opposite. Indeed, I see some good reasons now to bulk-up on small caps in context of a diversified approach.

3 Reasons You Might Want to Bump-Up Your Small Cap Allocation

When we start working with new clients at Zacks, we tend to notice that folks are under-allocated with small cap stocks. Often, the response we hear is that small caps are “too risky and volatile.” While this is true, relative to large caps, it is far less true when you factor in the potential long-term growth benefit. In that sense, it is arguably riskier not to own small caps.

A look at the last 15 years provides a good example for what I mean here. From 2000 – 2014, small caps (using the Russell 2000 Index) as a category have annualized +7.4%, compared to the S&P 500 which annualized a much lesser +4.2% over the same period. Looking back further, a hypothetical $1,000 investment in Russell 2000 at the start of 1979 was worth $29,742 at the end of 2014, while the same investment in the S&P 500 would have been worth $21,468. That’s a +2,874% gain versus a +2,047% gain, a difference that isn’t exactly a rounding error!

I’ve just argued for the long-term, total return reason to own small caps in your portfolio, but I think there are circumstances now that could boost the performance of small caps over other categories over the next year.

1) The Dollar Is Strong and Likely Getting Stronger – small cap companies consist largely of U.S.-based companies that derive a large percentage of their revenues and profits from domestic consumers. That means they are largely insulated from the hindrance to exports caused by a strengthening dollar, which multi-nationals “feel” on their top lines.

2) Rising Interest Rates Shouldn’t Hurt – a rising rate environment generally hurts small caps since they are more leveraged than larger companies. High levels of debt in a rising rate environment hurts small companies because interest payment costs rise. But since interest rates are basically zero bound and the Fed has made it pretty clear rate rises will come very gradually, this should not be as negative a factor where it has been in the past.

3) Merger and Acquisition Opportunities – often, small caps are the targets of M&A activity since they’re the easiest targets. That usually means a nice boost for stock prices, since the ‘acquiring companies’ usually have to pay a premium for ownership. In the U.S., if M&A activity continues at its current pace, it could reach $4.58 trillion which would be the biggest year on record.

Bottom Line for Investors

Small cap stocks have proven over the long-term that they deserve or, perhaps, even require a place at the table when investors are making asset allocation decisions. I believe this to be true over the long-term – and, I think the narrative of small caps being ‘too risky and volatile’ is causing investors to slight them when they construct investment portfolios.

At Zacks, we try to educate our clients about the long-term benefits of owning small caps, if doing so is appropriate given their goals and objectives. And for investors with long investment horizons seeking growth, this is usually the case. I also believe small caps are worth considering for the short term. As you know, investment success is all about the future, immediate as well as in the years ahead.

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Disclosure:  Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.This communication is for informational purposes only and nothing herein should be construed as a solicitation, recommendation or an offer to buy or sell any securities or product, and does not constitute legal or tax advice. The information contained herein has been obtained from sources believed to be reliable but we do not guarantee accuracy or completeness. Zacks Investment Management, Inc. is not engaged in rendering legal, tax, accounting or other professional services. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel.

[factorinvestor]

U.S. small cap: mediocrity lies at the intersection of maximums and minimums

Small capitalization stocks are an interesting breed. This portion of the markets contains thousands of names that are unloved and unappreciated. The space is a treasure trove for long-term and disciplined individual investors. In a series of posts, I will explore some nuances of the space that make it so incredibly appealing to the discerning investor. But, buyer beware because there is a lot of junk in small cap.

Dozens of studies have demonstrated that investors myopically focus on bottom line earnings. I'll add to that and say that the behavioral bias has morphed. Whereas the bias used to focus at the individual stock level, it is now the case at the index level. In a decidedly opposite twist of the classic cliche, investors can't see the trees for the forest. Why? The move to passive indexing has obfiscated the most basic principal of capitalism. Money should flow to the best opportunities for investor return.

How each of us defines, "opportunity" is subjective. Opportunity can be defined as a stock trading below book value, a biotech firm about to receive FDA approval, and everything in between. In the upper realm of high finance, this concept of opportunity is referred to as "intrinsic value". The avenue by which the market realizes intrinsic value is called "price discovery." Passive indexing is nothing more than allocating to the market, pro-rata based on a company's existing size. It, therefore, negates price discovery. Indexing is decidedly investing in mediocrity. Indexes are, after all, capitalization weighted AVERAGES by definition and construction.

Most investors may be surprised by the wide dispersion in returns of index constituents that exists. We looked at small capitalization stocks back to 1964 and found the group of stocks, weighted equally, returned 12.3% annualized over the 50+ year period. That roughly equates to the return of the Russell 2000® Index, though the index did not start until 1979. Now it gets interesting. We cheated by ranking stocks based on their future return over the next 12 months and put them into five buckets (quintiles). We then measured the average 12 month return from 1964-2015. Keep in mind, these exact same stocks generated the 12.3% annualized return I referenced earlier. If you were an investor with perfect foresight and you could invest in the bucket of stocks with the best forward 12 month return, your portfolio would return 65.2% per year for over 50 years. On the flip side of the equation, if you had some sadomasochistic tendencies and invested in the bucket of stocks you knew would perform the worst over the next 12 months, your portfolio would have returned -50.8% over the next 50 years. Again, these are the exact sames stocks that when combined in a weighted-average index return, generate 12.3% per year.

With an index investment, like the Russell 2000®, you get the best AND the worst. Our task as investors is to identify characteristics of successful stocks and orient portfolios towards the best performers, while eschewing the worst. Over the next several posts, I'll dive into the details of this unique playground for discerning investors.

[bencarlsonyahoofinance]

What If There Is No Small Cap Premium?

In the latest edition of Stocks For the Long Run, Jeremy Siegel offered up a great stat on the small cap premium. From 1926-2012, small cap stocks returned 11.5% per year while the large cap S&P 500 returned 9.7%. But if you were to exclude the 1975-1983 period, which coincides with ERISA laws that made it easier for pensions to diversify into small caps, the annual returns for both large and small caps would be almost identical at around 8% per year.

Of course those returns did happen and you can play that game with most historical data-sets, but the small cap premium has been called into question more and more as of late. You can look at historical data going far back into the past, but I prefer to look at actual products in the small cap space since it would have been quite difficult to put together a cost effective small cap portfolio before the 60s or 70s.

Surprisingly, the Vanguard Small Cap Index Fund (NAESX) has a performance history dating back to 1960. The annualized return through March 31 of this year is 10.84%. In that same time the S&P 500 returned 10.19% per year so there was a slight premium in this particular fund. DFA has a small cap fund (DFSTX) that goes back to 1993. The annual returns through the end of 2014 show this fund outperformed the S&P 500 by over one-and-a-half percent (10.94% vs. 9.36%).

So there are real funds that have shown an edge over longer time frames in small caps. People offer many reasons for the historical small cap premium — more risk, less liquidity, a smaller following by Wall Street analysts, not as easily investable by large institutional funds, etc. And these reasons make sense on the surface. But that doesn’t mean they’ll work going forward. No one really knows how these dynamics will change over time.

The days of making easy money in stocks are over (if they ever really existed). I don’t believe you’re not going to be able to make a minor tilt to a simple factor and watch huge profits roll in anymore. They’re too widely known and easier to invest in than ever. Small caps are just one example. Premiums will still exist, but my guess is they’ll get compressed. Maybe I’m wrong. It could be that investors just have to be willing to show more patience going forward.

But I think it makes sense to invest in small caps whether they earn a premium over large caps in the future or not. This is because they provide diversification benefits. Take a look at the cyclical nature of the return numbers on the Vanguard Small Cap Index Fund and the S&P 500 over the years:

Markets are messy, but to a diversified investor these numbers are beautiful. When one segment of the market had a relative string of underperformance, the other was there to pick up the slack. I don’t see this changing anytime soon as large cap stocks continue to become more global while small caps are more U.S.-centric.

There are other ways to invest in smaller stocks that have shown an even more impressive historical return record including a tilt to value or quality stocks within the small cap universe. Again, no one really knows how those risk premiums will fair in the future. But a portfolio with an allocation to small cap stocks should continue to provide a nice diversification benefit to investors that are able to look past the inevitable periods of relative underperformance.

That’s how diversified portfolios work. There’s always going to be something that’s doing better and something that’s doing worse. The payoff is that the disciplined investor earns a more balanced risk-return profile for their troubles.

Source: Stocks for the Long Run

Further Reading: What Happens When the Umbrella Shop Gets Too Crowded? The Small Cap Value Cycle The Small Firm Affect is Real and It’s Spectacular (AQR)

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This post from Ben Carlson (@awealthofcs) originally appeared on A Wealth of Common Sense.

Photo: 401k 2012

[jlfmi]

Value Stocks Get Their Turn To Shine

In early February we highlighted the emerging strength in small and mid-cap growth stocks. After languishing for over a year, they finally experienced breakouts, of which they have since built upon. Even during the 12+ months in which these growth stocks struggled, however, they had for the most part enjoyed the upper hand over their value counterparts. That said, their relative advantage has not been along a straight line. While growth has been the overall relative winner during that time, value stocks have had their moments to shine as well. Yesterday was such a moment. For the first time since last July, both small-cap and mid-cap pure value stocks registered convincing breakouts to all-time highs. (FYI, the “pure” growth and value indices include just those stocks within the larger universe that fit more stringent criteria consistent with each style as opposed to broader growth and value indices that, by rule, encompass all of the constituents of their larger universe.)

As the chart shows, the small-cap pure value index shot above lateral resistance to a new high. Meanwhile, the mid-cap pure value index broke above an ascending trendline to score its first new high of significance in nearly a year. While we have broader, long-term concerns about the market, there is little to argue with regarding the bullishness of such breakouts -- unless, of course, they immediately fail.

Additionally, over the past few years, growth and value have consistently ping-ponged back and forth in terms of short-term leadership. Therefore, the breakout does not guarantee that these value stocks will either A) continue their strength on an absolute basis or B) take over the leadership mantle from growth stocks overall. It is appropriate to keep in mind that on a relative basis, growth still holds the advantage over value for the time being. Witness the general downtrends that remain intact in the respective pure value indices versus their growth counterparts.

Thus, until the downtrends versus growth stocks are broken, value stocks are still at a relative disadvantage. However, as we said, on an absolute basis, the breakouts in the small and mid-cap pure value indices are a positive for those style segments (again, as long as they do not fail immediately). It is also a constructive sign for the overall market in the near-term that more and more broad averages continue to make new highs.

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"In Abe we trust” photo by Benjamin Mischler.

More from Dana Lyons, JLFMI and My401kPro.

The commentary included in this blog is provided for informational purposes only. It does not constitute a recommendation to invest in any specific investment product or service. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.

[captainjohncharts]

My Toaster says Hi to your Toaster

My Toaster says Hi to your Toaster

Evolution is here and by now you have heard of the “Internet of Things.” IoT. This is as big as the computer itself and it isn’t so much about the Internet as it is about all those “THINGS” that will communicate. Image that the Toaster can communicate with the Vacuum. The inanimate objects will now become animate.

No-one makes their own products and now they have to make toasters that think, (and…

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