We’re now in the midst of 18 straight up Tuesdays for the S&P500.  While this is a statistical anomaly, surely there is someone out there who thinks there’s an investing strategy to exploit this “trend”.  Perhaps buy leveraged ETFs on Wednesday nights and sell them Thursday nights?  Perhaps buy call options for even more leverage?  I know the wheels are spinning.  Unlike when I wrote about an actual observable and investable trend of investing on the 1st day of the month (there was a very pronounced positive alpha play here before the mainstream media caught wind of it primarily because of 1st of month fund flows from 401(k)s, pension plans, etc.), there is nothing here for Tuesdays I’m sad to say.  See, this is nothing more than a statistic occurrence that is just as likely to pop up in any given year.  Next year, we may just as well see 18 down Thursdays in a row.

Another school of thought may be the contrary (which shows just how silly this exercise is), which would posit that since we have had 18 up Tuesdays, surely we’re going to switch to having more down Tuesdays than would be expected to make up for this trend.  For instance, there are people who play Roulette who swear by keeping tabs on prior wins of red or black or numbers and make future bets based on where the wheel has landed in the past.  In some cases, they’re betting fortunes.  This is utterly absurd and mathematically impossible to predict future outcomes of random events based on past history.  Same with coin flips.  So, there are real-world similarities here regarding how other people think, but as far as a rational investor?  Do nothing different.  Invest for the long-term and ignore the sensational news blasts that will surely occur this week if we make it 19.

Low interest rates are starting to fuel an economic fire. In the financial markets, I believe low-yield alternatives are leading investors to pay up for less attractive dividend funds and junk bonds. (The Wall Street Journal said the same this week).

In the housing market, low interest rates are pushing investors back into single family homes, with prices rising at the fastest pace since 2006. New single family REITs are planning IPOs. On the consumer side, Americans are snatching up automobiles (many of which are financed for less creditworthy borrowers) at a pace reaching 15 million cars per year.

Low rates are bringing higher prices, just in select markets; the markets money reaches first. Past the financial markets, the housing markets, and consumer finance, easy money eventually makes its way into the prices for everything. For all the talk of low inflation, there seems to be plenty of money floating around in the financial markets.

Throwing gold and silver out

Moving a portfolio to position against inflation is often too binary. Many think that inflation must be met with precious metals and their miners.

Gold and silver mirror inflation over very long periods of time, but hardly from year to year, or even decade to decade. Also, mining companies are affected by inflationary pressures. Mining firms essentially trade human labor, energy, and steel into gold. Rising energy or labor prices can easily displace any gains from rising gold or silver prices. Oh, and let’s not forget that silver prices are really just a derivative of copper prices, which are driven moreso by economic development than simple inflation.

A move into bullion or bullion producers is near-sighted at best, nevermind much too concentrated on one industry. It’s time to lay the case for metals to rest. Temporary bull markets in gold make for investing legends, but boom often turns to bust.  For various ways on how to short these precious metals, check out 6 ways to short gold and silver.

Putting equities back in

As much as I believe stocks are fairly-valued, perhaps overvalued in some defensive sectors like utilities, their inflation resilience is unmatched. Some companies are better than others.

One of my favorite ETFs, a fund I continue to become more comfortable with, is a rockstar in the anti-inflationary trade. The Vanguard Dividend Appreciation ETF (VIG) holds very strong, resilient brands, most of which are in the consumer staples and consumer discretionary space, and many of which have pricing power.

Pricing power is all too often overlooked in the hunt for great businesses. It was pricing power that made Berkshire Hathaway what it is today. Munger jokes Buffett’s favorite strategy is buying a business, firing all the employees, and raising prices. He’s not too far off – although that strategy was much more prominent during the early days.

The point is that a brand’s pricing power is what protects its owners from inflation. Buffett paid $25 million for See’s Candies in 1972, invested little more than $30 million since, and pulled more than $1.3 billion from the company’s coffers to date. All of this was done on the back of one annual price increase every single year.

Finding pricing power

A natural place to look would be the Market Vectors Wide Moat Research ETF (MOAT), which holds 20 of the most attractively valued, wide moat companies based on Morningstar’s data. Unfortunately for investors, the fund’s incredible turnover destroys any value in a buy and hold portfolio. Stocks leave too quickly, before their long-term potential can be harvested for profits. The fund has, not surprisingly, underperformed.

Where next? Let’s go back to the Vanguard Dividend Appreciation ETF (VIG). Fund managers have identified companies with long-term pricing power.

Take a look at the list of top fund holdings:

All of these are well-known names, and only two (Chevron and Exxon Mobil) are commodity businesses. Proctor and Gamble owns several billion-dollar brands. Pepsi and Coke own sodas, with Pepsi also leading in chips and snack foods.

There’s pricing power abound in this portfolio. Wal-Mart has scale and the ability to control costs. IBM has a name tech trusts. McDonald’s has the best food at the price point. (Note: at the price point.)

From quarter-to-quarter, brands have no measurable value. All too often are big names hit when slight margin compression results from rising input prices and stable or slow-growing average selling prices. However, over the long haul, leading names have the capacity to increase prices at or above their input costs – and that’s what makes the Vanguard Dividend Appreciation fund the best pick for rising inflation. Not to mention, unlike other dividend funds, its lower yield pushes away current yield chasers, who are driving up asset values in every corner of the market.

These are large cap companies. They’re not going to be to your portfolio what See’s Candies was to Berkshire Hathaway, but when it comes to pricing power, Vanguard’s Dividend Appreciation ETF holds a basket of very exceptional brands. The yield is only a plus, which should help it continue a history of market-beating performance. In an inflationary environment, this fund would hold up extraordinarily well.

Disclosure: No positions in any ticker mentioned here.

Investors have been on the hunt for yield ever since policy pushed investors to risk assets to generate any real return. Yields on US Treasuries, certificates of deposit, and short-term corporate bonds is without question well below the rate of inflation.

Yields are certainly lower than the true rate of inflation as defined by the everyday price index.

Is yield overrated?

Playing the yield game is dangerous. For one, it’s easy to overlook the risk of capital losses when investors’ look at yield only. Secondly, when investors begin to seek yield from two very different asset classes – fixed-income investments vs. equities – rising stock prices follow as investors bid down a yield to match alternatives.

These are the three biggest signs that investors have gone too far in pursuit of yield:

1. Utilities are trouncing the S&P 500 – The Utilities SPDR (XLU) fund is one of this years’ hottest performing ETFs, up more than 17% year-to-date compared to SPDR S&P 500′s (SPY) 13% return. The rise of the utility sector is partly due to a late year 2012 sell-off when investors feared the possibility of higher dividend and capital gains taxation in 2013. I wrote then that utility ETFs were a relative value, and that the risks of rising dividend taxes was overblown. Now, with the utility sector rising quickly, utility stocks trade at more than 16 times forward earnings estimates while paying out only 3.55% in yield. Utilities trade at a premium earnings multiple to the broad market but have below-average potential for earnings growth. If investors only want yield, utilities are a good place to find it. But total return has to called into question at the current multiple.
2. Junk bond rates hit record low – Companies which source funding from the junk bond market are currently borrowing at the lowest rates in history. Barron’s has actively tracked this trend, posting near-daily updates about the ever-plunging costs of debt financing for companies with weak balance sheets. The retail investors’ access to the market for junk-rated debt securities improved dramatically after the launch of several successful junk bond funds. These index funds are partially responsible for a surge in junk bond values. The average junk bond now trades at 5 cents over par value. SPDR Barclays Capital High Yield Bond ETF (JNK) is up 4.5% in total return since the beginning of 2013. Junk bonds provide evidence for extreme yield chasing. In an earlier article, I wrote of an actively-managed junk bond ETF that was beating the benchmarks because it could find more attractively-priced bonds that aren’t in junk bond ETF indexes.
3. Investors are becoming more active – Fund flows show that investors are starting to get more aggressive about how they allocate money to new funds. The largest 100 ETFs have a smaller share of fund assets than last year, 77% vs 82% while the largest 50 have 62% compared to 69% of all assets in 2012. Forty-two percent of funds are flowing into funds that are not market-cap weighted, according to data from BlackRock, which indicates a shift in how people are taking to the markets. New investment styles are certainly driving the trend as investors begin to invest more time into smaller, niche ETFs. There’s an ETF for everything – from a recently-hot hedged Japanese equities fund to dividend and junk bond ETFs that lapped up inflows in 2012.

When high yields aren’t high

When risk-free and AAA-rated corporate bonds yield less than 4%, 3.5% yield on utilities and 6% yields from junk ETFs are difficult to pass up. (For historical reference, yields in the high-yield space were in the double-digits in 2010). The risks of capital losses fall out of the decision-making process. Dividend growth investing has become a new “trendy” thing in the world of retail finance. Investors buy the yield, and assume they’ll simply hold forever, thus removing the consequences of capital losses. Rarely does the retail investor stick the game plan, however.

Historical data obscures the effects of the great recession. 3-year data is all positive. Next year, 2008 declines will fall out of 5-year data, painting an even rosier picture for investment returns.

This yield trade, much like the trade in gold and silver, has to reverse at some point. When it does, we’ll really see just how willing investors are to hold a capital loss greater than several years of dividend payments. My guess is that investors aren’t as patient as they might claim.

Disclosure: No positions in any tickers mentioned here.

You’ve probably seen news accounts recently that equities markets in various countries are hitting new highs and continue to rally in spite of whatever alarming news exists in the economy, Europe, and the geopolitical landscape.  There are good reasons for this, while other facets of this rally leave many scratching their heads.  Regardless of what you’re seeing in daily news accounts, there are 3 reasons why it may not be too late to join the equities rally if you’ve been sitting on the sideline thus far, still licking wounds from the crash of 2008-2009.

• The Economy Doesn’t Matter, Only Corporate Profits Do – It’s taken me a long time to come to terms with this fact, but the economy can be in complete shambles, yet we can see stock market rallies in spite of it.  Putting aside the contrived “unemployment numbers” which, depending on which country you live in, exclude things like people that have simply given up looking for work or enjoy the disability fraud bandwagon, consider looking at actual “employment” rates. It’s abysmal, especially in the under 30 crowd globally, which does not bode well for civil unrest.  However, corporate profits continue to shine.  Companies have become so lean during the recession, that as demand resurfaced, they were able to scale back up with the same automation and outsourcing that they learned to leverage in a declining market in prior years.  So, while consumer spending has picket up, and sales increase, they’re not adding headcount at nearly the same rate.  That’s resulting in profit expansion.
• Global Interest Rate Manipulation Continues to Force the Risk Trade – This one was relatively easy to call early on, but in retrospect, now it really seems like a no-brainer.  Interest rates are so low, there’s simply nowhere else to invest!  Bonds are becoming too frothy and are subject to crash themselves.  They’re losing money to inflation. So are banking options like savings, money markets and CDs.  So, at least equities usually pay a dividend and have the prospect of capital appreciation!  The federal reserves globally, in a concerted effort, have been pushing investors into the risk trade.
• You’re Not a Market Timer, So Invest Per Your Strategy Now! – While on one hand you might feel like a market timer by jumping into a hot market, I’d say that you’re being a market timer by sitting out!  If you’re young and have a long time horizon, you should have been in stocks all along.  It’s the only way, especially now, to have any shot at beating inflation and other conventional asset classes over the next decade or two.  As long as equities make sense in your strategy, stop sitting it out waiting for that next crash – it may be 5 years off!

So, for an initial investor without the traditional company-sponsored investment plan, it’s as easy as starting up an online brokerage account and buying some ETFs or with even less effort, to just buy a broad market mutual fund from the likes of Standard Life.  You can basically set it and forget it, assuming your time horizon is quite a ways out.

I’m sometimes confounded by people who say they are very conservative investors and are unwilling to take on the routine equity volatility risk that is, well, pretty much necessary to beat inflation these days.  Yet at the same time, they carry no insurance of any sort for all the various unforeseen events and maladies that could occur.  While investing and insurance are two distinct financial topics, they both involve risk – and you’d think people would either be aggressive or conservative with both, no?

Various Types of Insurance

• Auto Insurance – Of course, this one’s a given.  In the US and many other countries, it’s required by law.  There are of course, varying levels of coverage, depending on your confidence as a drive, whether or not you drive a beater, and what kind of premiums you can afford.  Younger drivers pay an especially high price given the actuarial data showing their propensity for accidents.
• Health Insurance – This has been a major topic in recent years, but above and beyond the basic coverage required and Obamacare’s tenants, there are other side considerations.  For instance, to try and drive some tax benefits, I max out my Flex Savings Account, and people can optimize the type of plan they choose based on their family situation and the deductible they want to pay.  Younger people who are virtually never in the health system often shoot for a higher deductible, lower fee plan.  This changes as they age of course.
• Life Insurance – Here’s another one I’m often surprised people go without.  I just got the bill for my wife’s policy so this was fresh in my mind.  Even though she’s not working now, in the event of her demise, I’d obviously have lots of expenses ranging from childcare to trying to replace some of her future income we planned on when she returns to the workforce.  Again, if one is truly risk-averse and worried about losing a portion of their investment  funds in the stock market, how would the prospect of losing a spouse’s income and financial contributions not cause concern?
• Mortgage Protection – So, while the above example subject may be risk-averse and avoid stocks altogether, they aren’t worried about loss of income causing them to lose their home?  There are options out there to protect against such an outcome like mortgage protection.  I suppose much depends on what one’s assessment is of the likelihood to incur long-term disability, illness, etc., but it just seems odd to be unwilling to take any market risk while ignoring all the other risks out there.

Netflix (NFLX) may be this year’s best performer as a provider of internet TV, but investors are seeing impressive gains in media as a whole.

PowerShares Dynamic Media Portfolio (PBS) ranks among several leveraged funds and Japanese equity ETFs as a top YTD performer. The fund tracks an index of 32 different media companies, most of which are in traditional cable programming businesses. The fund is up 20% year-to-date as investment capital flocks to strong media outlets.

What’s right for media?

Media companies are difficult to value. Companies like Discovery Communications Inc (DISCA) and Walt Disney Co (DIS), the two largest holdings in the PBS fund, derive their value from their content and intellectual property. Media companies cannot make more cash flow-producing intellectual property at the snap of their fingers.

Walt Disney, for instance, has a roster of highly-valuable characters and franchises, from Toy Story to Mickey Mouse, as well as a successful cable business led by ESPN.

Here’s why investment capital flocks to media companies:

1. Consumer discretionary plays are “in” – Media companies are classified as consumer discretionary, but they might as well be consumer staples. This year, and for much of the past decade, consumer staples have been a favorite of investors for their consistent revenue and bottom line profits.
2. Subscription models are for the long haul – Cable operators make money on subscription. ESPN is the leader of creating value from cable companies. It typically charges $4.69 per subscriber, while other channels receive pennies per cable subscription. Customers do not come and go. Once signed, a cable contract pays out for decades.
3. Higher revenue for cable brings opportunity – Cable companies like Comcast are dealing with the slow decline in cable with higher prices. Cord-cutting begets higher prices for remaining subscribers, while content creators see price hikes as a way to grab more income from cable companies. The difference between what a cable company pays for content and the average cable price per subscriber is money content creators eventually pull for their own.
4. Advertising is heaviest in strong markets – The PBS fund has some exposure to advertising. Its position in Yahoo and Google, for instance, is a pure-play on growing internet advertising spend. As the economy recovers, businesses that rely on a marginal increase in ad spend rally due to operating leverage.

Prominent investors have always been in the media market. Warren Buffett’s Berkshire Hathaway (BRK.B) has significant stakes in Direct TV (DTV), The Washington Post (WPO), Viacom (VIAB), and Stars (STRZA).

Why the Media ETF Makes Sense

Unlike other sector ETFs, a media portfolio offers excellent opportunity because of a lack of price competition. Whereas two retailers can destroy one another through price wars, movies, cable content, and online advertising are markets where competitors rarely compete on price. There is an established market value for advertising, and rival movie producers do not seek to attract audiences with lower ticket prices. Businesses in the space compete mostly on product quality, which lifts the industry as a whole without the destructive effects of price competition.

As a group, the 32 media companies in PBS’s portfolio offer excellent diversification. The top 10 holdings are as follows:

1. Discovery Communications (DISCA) 5.19%
2. Walt Disney (DIS) 5.01%
3. Yahoo (YHOO) 5.00%
4. Time Warner (TWX) 5.00%
5. Google(GOOG) 4.99%
6. CBS (CBS) 4.99%
7. Time Warner Cable (TWC) 4.98%
8. Comcast Corp (CMCSA) 4.97%
9. Lamar Advertising (LAMR) 2.88%
10. Netflix (NFLX) 2.84%

In just the top 10 grouping, Powershares positions investors for exposure to movies, cable content, online advertising, outdoor advertising, and internet and cable TV. The fund has outperformed the S&P 500 index in all relevant periods from YTD performance to the last five years.

Investors who want a strong portfolio in the consumer discretionary space should certainly consider a position in media. The business is certainly changing – Netflix is trying to usurp Comcast and traditional media, while advertising shifts from commercials to product placement – but the profits are not. Media is a cash cow, and this fund is certainly worth owning for those who want broad exposure to the industry at a manageable price of .63% per year.

Disclosure: No position in any tickers mentioned here.

One of the key tenants of successful investing is proper diversification.  But can diversifying assets and classes be taken to such an extreme that it’s detrimental to returns?  Back when I was a more active investor trading individual stocks on a more routine basis, I used to question the wisdom of professional fund managers owning hundreds of stocks and trying to “beat the market” when virtual market correlation occurs with like 25 holdings or more.  But then you start branching out into various asset classes, often with zero or even negative correlation, and then you start to wonder if the individual investor is going overboard.  Thinking through some key asset classes, here are some thoughts on performance, correlation and where the proper mix may lie:

• Stocks – This is the old standby, and in terms of conventional asset classes, over decades-long periods of time, tend to deliver 8% or greater returns when considering dividends.  Volatility is high though, which many investors cannot stomach, especially over short periods.
• Bonds – Bonds had traditionally been the antidote to the volatility of equities, which a rather predictable yield and relatively steady volatility.  However, with the various QE schemes, there has been so much money thrown at bonds, that yields have reached generational lows and many feel investors could be really burned by a major bond selloff within the next few years.  Many professionals don’t view bonds as the safe haven they used to be.
• Gold – Gold had garnered a lot of attention over the past few years as a “store of value” and alternative to fiat currencies, but gold too has sold off of late.  While many suggest a 5-10% balance in total assets, I personally don’t see much value in holding gold.  In a state of inflation, I’d sooner hold real estate or dividend paying stocks.  Gold pays no dividend and can sell off just as quickly as stocks when margin calls come in.
• Real Estate – The beauty of real estate is leverage and income.  Owning individual real estate comes with incredible capital and time commitments, especially up front.  But this can end up yielding the greatest net return of all asset classes if done right.  An easier approach is REITs, but returns are likely to be muted.  Many REITs yield north of 5% though and tend to track roughly with the market at large in terms of price appreciation.
• Other/Alternative – This can span everything from currencies to niche sectors like art, wine, collectibles and land to even the newfangled Bitcoin phenomena (of which I am not a fan by the way).  Peer lending is another alternative source of income.

At the end of the day, a key reason for diversifying into low/negative correlation assets is so you can sell when the market crashes and rebalance.   Or, if you actually needed the funds in the interim, you could sell off your strongest performing assets while they’re high as an artificial rebalancing scheme, whereas if everything crashes together, you’re selling low.  My thoughts on this though, are that, during a true market crisis, even non-correlated assets can all sell off.  We saw during the financial crash, flash crash and other panics, that when equities sold off, so did gold, commodities, real estate and other asset classes that people traditionally used to diversify out of stocks.

Secondarily, it begs the question as to your time horizon.  If you plan on being in the market for the next 30 years (say, 401(k) fund selection considerations), does it really matter whether you have diversification if you don’t intend on ever selling during that period?  Or, rather, should you instead focus solely on what would be likely to delivery the greatest possible return by the end of the period (equities)?  For this reason, I tend to keep my investment funds in retirement accounts set at near 100% equities.