11:30pmCT, Friday, January 23, 2015 “On the Day After the EU & ECB’s QE… POSTRIDIE EIUS”

11:30pmCT, Friday, January 23, 2015 “On the Day After the EU & ECB’s QE… POSTRIDIE EIUS”

“POSTRIDIE EIUS”

“THE DAY AFTER”

On Friday, on the day after the EU & ECB’s QE, (when Mario Draghi’s ECB made a rate decision to leave rates unchanged, and to offer Quantitative Easing of nearly 60 billion Euro per month (until at least Sept of 2016, and also until at least 2% inflation)), U.S. major stock indices sold off slightly, but finished up strongly for the week.  On Friday, the VIX rose +1.59% to 16.66.  The DJIA sold off, -141.38 points or -0.79% to 17,672.60. The S&P500 fell -11.33 or -0.53%.  The S&PMidCap400 declined -6.50 points or -0.44% to 1,455.79.  Equities slumped, generally speaking, mostly during the final two hours and ten minutes of trading, when the DJIA shed about 120 points of its 141 point decline.

Note how the 10 year T-Note yield is now 1.79%, while the S&P500’s dividend yield is 1.97%, and the DJIA’s dividend yield is now 2.46%.  This (these stock indices yields greater than the 10 year T-Note) is very very bullish for equities going forward a year, based on long term past performance.

In fixed income, Treasuries rose today, as measured by ticker AGG, which closed up +0.28 or +0.25% to 111.71.  The etf ZROZ closed up +1.68% or 2.20 to 132.83.  Ticker TIP closed up +0.61% or 0.69, closing at 114.32.  IEF was up +0.65% or 0.71 points to 109.24.  Today the 10 year T-Note yield closed at a yield of 1.79%, the 30 Year T-Bond yield closed at 2.37%.  The high yield sectors of fixed income also rose today. Here’s how the high yield fixed income etfs did for today. EMB rose +1.18% to 111.65, PCY rose +1.42% to 28.66, HYG was unchanged closing at 90.01, JNK rose +0.03% to 38.84, and QLTC declined -0.64% or -0.3096 to 48.3904.

The Euro closed down Friday, losing -1.39% to end at 1.1207 versus the U.S. Dollar, a year ago it was at approximately 1.36;  Five years ago approximately 1.42.

QE is designed to depreciate the currency practicing it, in an effort to raise exports on an exchange rate basis, to make your own exports cheaper for foreigners.  I suppose printing your own money (if you’re a central bank) and then simultaneously purchasing your own debt (your own bonds, notes, and bills) is analogous to a corporation who prints its own common stock (in a secondary offering), and then retires its debt, but purchasing its fixed income previously issued (or currently being issued) back.  It’s good to eliminate debt.  This helps to stimulate the economy.  Printing money to purchase your own bonds, if you’re the government, also helps to mitigate the effect of crowding out investment and crowding out borrowing, since the cash isn’t being soaked up by investors, but is instead printed by the Central Bank.  When a government buys its own bonds, it then owes itself money, and earns interest (which it also owes to itself… kind of like your left hand, owing your right hand money!); This is similar to retiring the debt, and it also helps to reduce interest rates.  However, we already see interest rates in the Euro Zone at nearly zero, and literally also already into negative territory.  Perhaps, someday, people will realize they want to earn interest themselves, rather than pay a central bank while holding and owning fixed income.  Negative rates don’t really seem conducive to savings.  Even rates at zero a phony to me.  Who would lend money to anyone at zero?  They’d be ripping themselves off!  Who would lend money at negative rates?  That’s really ripping yourself off!  It’s lunacy to me.

Hell, if I could, I’d borrow money at 0.00%, or any negative rate you’d like! Perhaps I’d buy some Treasury securities with that free money lent to me at zero, or with the money you gave me, plus the money you’d owe me later, if I “borrowed” it at negative rates.  What a good one!  I wish I could borrow myself this way well into the trillions of dollars.  Wouldn’t you?

Oil traded down today, closing -1.55% or -0.72 to $45.59 per barrel.

Notable EPS releases that are up and coming soon, include XOM on February 2nd (before the market opens). CVX reports on Friday, January 30th (before the market opens); and BP on Tuesday, February 3rd (before the market opens).  MSFT reports on Monday, January 26th (after the close).  AAPL reports on Tuesday, January 27th (after the close), surely there will be a lot of HYPE(!!!) surrounding that EPS report.  AMZN reports on Thursday, January 29th (after the market close).  QCOM reports Wednesday, January 28th (after the market close).

On the Economic Release Calendar of events for next week, I believe the potential market moving events include Monday’s Dallas Fed Manufacturing Survey at 10:30amET.  Tuesday’s S&P Case/Shiller HPI at 9amET.  Wednesday’s EIA’s Petroleum Status Report at 10:30amET.  Thursday’s notable releases will include Jobless Claims at 8:30amET, and Pending Home Sales Index at 10:00amET.  Friday’s reports will include GDP as well as the Unemployment Cost Index both at 8:30amET, and the Chicago PMI at 9:45amET, and finally Consumer Sentiment at 10:00amET.

If I had to take a guess, I’d say (this is what my “crystal ball” is telling me) that next week will be relative quiet, until the Economic Calendar of events on Thursday and Friday rock the boat a little bit.  I’d like to think the reports will bring a rally to higher stock prices.  I’d also suggest that AAPL stock will likely increase after its EPS release, it nearly always does post its earnings reports, but this is just an observation I’ve made over the years, obviously past performance isn’t indicative of future performance (and four letter ticker symbols are like four letter words to me sometimes… on the that note the Nasdaq has traded down over the past nearly 15 years).  I’d also suggest that oil will continue to trade in a wide range, with wild and violent swings to the upside and downside, nearly every day, and I believe that an at-the-money straddle could potentially be very lucrative on ticker USO, choosing expiration dates going out about two weeks.  Ticker HAL and its EPS report of last week proved to be received very well by investors, this bodes well for the energy sector going forward.  I’d also like to note that XOM, CVX, and BP have literally beat their EPS reports over the past two to three quarters, despite the extreme sell off in the price of light sweet crude oil since June of 2014.  However, despite them beating their EPS consensus estimates, shares have obviously declined substantially since June of 2014 all across the energy sector (this is readily apparent in the share price of etf XLE).  Swim at your own risk!  Perhaps, a married put aka a protective put trade would be lucrative for energy stock investors, or investors in ticker USO.  I’d be tempted to purchase puts in-they-money, going out at least 3 to 6 months, combined with the stock purchase, for construction of the hypothetical protective put trade.   The energy sector’s stocks, and oil is so wildly volatile, sometimes I think I wouldn’t touch the sector with a ten foot pole!  I believe, once energy prices stabilize and begin to ascend though, there’s going to be some major opportunities in the energy sector, and in the high yield fixed income markets.

Well that’s about all the news that’s fit to print.

By Andrew G. Bernhardt

8:45pmCT, Friday, January 16, 2015

Here’s the current PE Multiple and Dividend yields of major U.S. stock indices.

In this post I discuss Index Dividend Yields, Index PE Multiples, Annualized Past Performance, Asset Allocation, Options & Derivative Securities.

As you can see the DJIA is quite reasonable in terms of  PE Multiple, at just 16.19, with forward looking estimates placing its PE Multiple at 15.33 in twelve months time; while the DJIA’s dividend yield has actually increased over the past 12 months to 2.51% from 2.08 a year ago.  This makes me most bullish on the DJIA, and I believe it will outperform the rest of the major U.S. stock indices in 2015 for this reason (the lower pe multiple, relative to other indices, and the strengthening dividend yield on this index).  DIA is an etf that matches the performance of the DJIA, which is a basket of 30 large super capitalization stocks representative of the U.S. economy.  Of course there are options on DIA, and also the CBOE has root symbol DJX and index options on the DJIA with 1256 contract status, which have preferential tax treatment, and cash settlement and European style assignment.

For educational and informational purposes, using options, one could hypothetically construct a portfolio with e.g. 20% allocation to index options achieving 5:1 enhancement, and then he/she could allocate the remainder, the 80% into e.g. high yield fixed income via etfs QLTC, EMB, PCY, JNK, and HYG (alternatively they could use Treasury etfs, e.g. AGG, IEF or TIP, or high quality corporate fixed income etfs e.g. LQD and many others).  This would likely produce awesome gains annually, if rebalanced annually.  This type of strategy is suitable for institutional trading, and it achieves the “best of both worlds” in terms of a large fixed income portfolio, for safety, and then an index option which would effectively capture the gains of the stock market over e.g. the course of a year or two.  A lot of investors, including institutional investors, “dilute” their equity portfolio’s potential gains with fixed income, which over time can produce returns less than the stock market (assuming high yield bonds are not employed).

What most people don’t know is that e.g. the JPM EMBI [which stands for the J.P. Morgan Emerging Market Bond Index] (matched by etf EMB, and many other higher cost mutual funds, like FNMIX, PEMDX, and GSDAX) has produced annualized gains over the past which are awesome, sometimes beating stock indices.  Over the past 12 months (according to https://fundresearch.fidelity.com/mutual-funds/performance-and-risk/315910836 the JPM EMBI has returned (through December 2014) +5.53%, and over the past 3 years the annualized return was +5.33%, over the past 5 years the annualized return was +7.21%, and over the past 10 years has produced annualized gains of +7.68%.  The high yield bond markets and high yield fixed income indices (rated BB or better, and the etf EMB meets that requirement) have never returned a negative return over any rolling 18 month period of time. This means that if there ever is a selloff in these fixed income indices it’s most likely a major buying opportunity, and based on past performance since the stone age, that the index will strike a new all time high within 18 months.  This is not the case for equity indices, which e.g. took 25 years from 1929 to 1954 to break even, even before inflation adjustments; also the Nasdaq Composite hasn’t reached it’s March 2000 levels of roughly 5,134, also before inflation adjustments, and it has been 15 years!  The etf PCY is very similar to etf EMB and has a slightly longer average weighted maturity, compared to EMB; It was designed by Deutsche Bank to outperform the EMB by 200 bp per year. Other corporate U.S. high yield bond funds rated BB or better include JNK, and HYG; of course there are many others.  There are also higher risk CCC rated fixed income mutual funds and etfs, including QLTC.

I have personally annualized the S&P500, and it has returned over the past ten years +5.238%, going from a December 31, 2004 value of 1,211.92 to the current 2,019.42 (derived from [2019.42/1211.92]^[1/10]).  Yes, you’re reading this correctly, high yield fixed income (as measured by the JPM EMBI) has outperformed the S&P500 over the past 10 years, each and every year (on average) by nearly +2.44%, and an extra 244 bp adds up quick over long periods of time.  It is said there’s nothing more powerful than compound returns.  Over the past 20 years the S&P500 has risen from 459.27 to the current 2,019.42, which annualizes to +7.6857% over the past 20 years through today (derived from [2019.41/459]^[1/20]).  I’d rather have bond market (aka fixed income) risk(s) than stock market risks.

Speaking of fixed income risk, here they are: Fixed Income Securities (including U.S. Treasury Securities) have default risk, interest rate risk, inflationary risk, liquidity risk, currency risk, credit quality risk, repayment or principal risk, streaming income risk, reinvestment risk, duration risk, convexity risk, maturity risk, market risk, political risk, and taxation adjustment risk, despite the caveat of “full faith and credit of the US Government” for US Treasuries.  Makes you wonder doesn’t it!  Just joking, obviously, fixed income is safer than equities, even when analyzing high yield fixed income indices.

Here’s the annualized data on the DJIA, which I have just personally calculated for you.  It closed today at 17,511.57, and in December of 1994, the last trading day of the year it closed at 3,834.44. So for 20 years the annualized DJIA return has been +7.890% (calculated from [17511.57/3834.44]^[1/20]).  For ten years the annualized return for the DJIA  has been +4.968%, going from 10,783.01, on the last trading day of 2004, to the current 17,511.57  (calculated from [17511.57/10783.01]^[1/10]).

In December of 2004, on the last trading day of the year, the S&PMidCap400 closed at 663.31, today it closed at 1,430.89; This annualizes to +7.991%, derived from [1430.89/663.31]^[1/10].

This is why my main “master strategy” (which after trading options for ten years I believe to be the best) has been to amplify the stock indices (rebalanced annually) using stock index options (which for safety have an expiration date going out more than two years), with 10 to 25 percent allocations, and enhancement ratios of 5:1 to 7:1 (this would require a level II purchase of a deep in the money call index option, and perhaps the selling or writing of an out of the money call, to mitigate extrinsic value decay, by turning the trade into a level III e.g. vertical bull call debit spread— potentially making the options positions theta positive); while placing the remainder, the 75 to 90 percent, into high yield fixed income.  I’m sure you can do the math, to discover what that hypothetical portfolio construction strategy annualizes, based on long term past performance figures.  Amazing isn’t it?!  Who can beat that?!

By Andrew G. Bernhardt