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2015-07-01 16:24:33

Posted by
Barron's

Contributor

Options

Netflix, Amazon Trade Is a Win-Win: Goldman

Thanks to a pricing anomaly, investors will profit whether the stocks rise or fall, Goldman Sachs says.

 

Goldman Sachs is telling clients to aggressively trade Amazon and Netflix ahead of their pending earnings reports.

Due to an anomaly in how the options market is pricing both stocks, Goldman says investors can initiate strategies in Amazon.com (ticker: AMZN) and Netflix (NFLX) that pay off if the stocks rise or fall in reaction to earnings news.

This may seem too good to be true, but Goldman’s recommended “straddle” strategy — buying a put and call with the same strike price and expiration — does indeed position investors to make money if earnings news causes Amazon and Netflix to make big stock moves higher or lower.

The strategy works because puts increase in value if stocks decline just as calls increase in value if stocks advance.

Goldman’s derivatives strategists, Katherine Fogertey and John Marshall, are telling clients the options market is incorrectly pricing Amazon and Netflix ahead of earnings. This lets investors buy Amazon and Netflix options without paying the usual fear or greed premiums that inflate options prices ahead of key events.

Over the past eight earnings reports, Netflix stock has moved an average of 13%, up or down, in reaction to earnings news. The options market is now pricing Netflix as if the stock will move 9%, up or down.

Over the past eight earnings reports, Amazon’s stock has moved 10%, up or down, in reaction to the news. The options market is now pricing Amazon as if the stock will move 8%, which would be the lowest earnings reaction on record since 2004.

To trade Amazon, Goldman is telling clients to buy Amazon’s August $435 put and call at a total cost of $45.55 when the stock was at $434.09. The bank estimates Amazon will report earnings July 24, though the company has not yet confirmed the date.

Goldman Sachs says that buying an Amazon straddle five days before earnings and closing out the position the day after earnings produced an average profit of 25% over the past eight quarters.

To trade Netflix, Goldman is telling clients to buy Netflix’s July $657.50 put and call for a total cost of $66.95 when the stock was at $656.94. Netflix will report earnings July 15.

Buying a Netflix straddle five days before earnings and closing the day after earnings, according to Goldman, produced an average profit of 60% over the past eight quarters.

Should the stock prices change by the time you read this trade recommendation, adjust the straddle strike prices to matching the stock prices.

The central fact of the trades is this: If the stocks move more than the money spent to buy the straddle, the trades are profitable. If the stocks move less, the trades are losers.

While the recommended trades are attractive, they are not suitable for everyone. Traders just starting out, like some of those who recently e-mailed me with questions, should consider the Amazon and Netflix trades as case studies. It is better to watch how the strategy works rather than trying to take advantage this time around.

The key to investing is managing risk. This is doubly true in the options market. One of the 5 Rules of Options Trading (please read them if you have not) is the Good Investor Rule: Bad investors think of ways to make money. Good investors think of ways to not lose money. This crucial truth permeates the options market. Most traders don’t understand it, and pay dearly.

Some investors will balk at spending so much money to trade earnings events. They will argue, and they will not be wrong, that investors with directional views on Amazon or Netflix can use the current options mispricing to trade stand-alone puts and calls.

But the earnings straddle trade tends to be a winner. Goldman believes options on stocks that trade above $100 cause sticker shock among most investors. Hence, the bank’s strategists theorize, options on expensive stocks tend to be inexpensive ahead of earnings.

A study of trading earnings since 1996 revealed that options on stocks above $100 were “systematically underpriced” relative to the less expensive stocks. The Goldman study found that buying straddles on stocks above $100 produced positive returns during 14 of 19 years and in five of the past eight quarters.

Investors who can live with those odds will be hard pressed to find two better earnings trades than Amazon and Netflix.

 

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This article is from Barron's and is being posted with Barron’s permission. The views expressed in this article are solely those of the author and/or Barron's and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

2015-07-01 14:58:15

Posted by
Fariba Rosanni
CEO, Elite Wealth Management Inc
Contributor

Stocks

What the Sudden Wave of IPOs Means for the Stock Market

Article Summary

  • June is on track to register the highest number of initial public offerings in 15 years.
  • The mix of low volatility and sudden IPO activity could be a dangerous mixture as investors look for growth opportunities in a stagnant stock market.
  • There is a correlation between heavy IPO activity and stock market corrections.

 

Investors haven't had a whole lot to cheer about in recent months. The constant threat of a Greek default, wild swings in the price of oil, and uncertainty about the upcoming Fed Funds rate hike has infiltrated investor sentiment. The markets have basically traded sideways since late February waiting for either good news or bad news to finally tip the scales to send them higher or lower.

The S&P 500 is only up 2.10% year-to-date with nearly all of those gains having been achieved in the first two months of the year. Since its high in February, the S&P 500 has actually fallen 0.70%. The only index that's actually performed well so far has been the tech-heavy NASDAQ which is up 7.94% year-to-date. Although much like the other indices, it too has stagnated since February.

In the past couple of weeks, investors seemed to have finally received the information they've been waiting for. With the recent upside surprise regarding the jobs number, investors are more confident in the Fed's direction and timeline regarding its plan to raise interest rates this year. As uncertainty begins to give way to confidence, volatility should continue to fall as well. The VIX has fallen for the past two weeks and now stands at around 13 - a low figure that means there is remarkably little uncertainty and volatility in the financial markets. It's giving investors a renewed sense of hope for the economy and it's triggering a wave of fresh new IPOs along with it.

IPOs are all the rage for investors

Adding to the positive momentum that's building up is the sudden surge in IPO activity. After a lackadaisical start to 2015, initial public offerings are back in vogue with a vengeance. With around 17 IPOs set to debut during this week of June 22nd alone, this month is on pace to be the strongest month for new offerings since 1999 - more than 15 years ago. The total number could be as high as 34 for the month of June and encompasses a variety of market sectors.

So far for 2015, many IPOs haven't been able to deliver on investor expectations. Several popular names like Etsy (NASDAQ:ETSY), Fogo de Chao (Pending:FOGO), and Box (NYSE:BOX) have plummeted since their initial few days of their respective IPOs. Etsy looked like a sure-fire winner on its first trading day skyrocketing up over 88% but has since fallen off precipitously from a high of $35.74 to around $15.00 where it's currently trading.

The big winner so far this year is Shopify (Pending:SHOP). It's up 104.9% year-to-date despite coming down off of its high of nearly 150% back in May. Yet despite the lack of consistency, investors are still hungry for the latest IPO.

Last week saw the long awaited debut of the $4 billion-plus tech "unicorn" Fitbit (NYSE:FIT) which opened to extremely widespread interest. The stock soared 48.4% on opening day with over 40 million shares trading hands. While it's still too early to say which direction the stock will ultimately head in, the fact that it controls 85% of the wearable fitness tracker tech market means that it's in an ideal economic location to thrive right now.

Up-and-comers to the IPO scene this week include the credit reporting agency TransUnion which joins the already publicly traded Equifax (NYSE:EFX) and Experian (EXPN) and Alarm.com which provides a cloud-based security system for residential usage.

Investors seem all too willing to climb aboard the suddenly hot IPO market. The reason could be the lack of opportunity this year given the health of the IPO scene for the past couple of years. In 2013, 222 IPOs debuted and in 2014, 275 IPOs were issued. Coming into this week, only 86 IPOs have been priced. The sudden surge in activity has been a welcome sight for many investors who have been waiting for the market to heat back up again.

A look back in history tells us that a surge in IPO activity might be a warning sign

The sudden flurry of IPO activity is due to the positive gains the market has been putting up. Companies try to wait for the market to establish bullish momentum before issuing stock in order to generate as much positive interest as possible. The Fed's upcoming rate hike is likely another reason companies are issuing IPOs en masse right now. It's a good opportunity to issue stock now before the Fed raises interest rates.

It's interesting to note however, that the last time IPO activity was up this much was back in 1999 - just before the tech bubble burst in 2000. The market might be showing strength right now, but it could also be the last call for companies trying to get public before the market turns south.

Value investors might be familiar with the works of Benjamin Graham, one of the founders of the value investing principles and mentor to Warren Buffett. In his book, The Intelligent Investor, Graham specifically points out that the proliferation of IPOs is a correction sign.

"Bull-market periods are usually characterized by the transformation of a large number of privately owned businesses into companies with quoted shares. This was the case in 1945-46 and again beginning in 1960. The process then reached extraordinary proportions until brought to a catastrophic close in May 1962. After the usual "swearing-off" period of several years the whole tragicomedy was repeated, step by step, in 1967-1969."

-Benjamin Graham, The Intelligent Investor, p. 140

The problem with new issues is two-fold. IPOs generally come with a sales aspect meant to put on a positive spin on the company leading investors to believe in "hype" rather than solid fundamentals. The other problem is that IPOs generally take place during favorable market conditions which tends to benefit the issuer rather than the buyer. New stocks need to be properly vetted and researched before investors should consider purchasing into them, however, during a wave of new releases that type of due diligence is often disregarded. The general belief is that "a rising tide will lift all ships."

Investors that might not normally invest in speculative stocks might be interested in IPOs simply because of the environment of their personal beliefs in the company itself without getting financial details beforehand. This dissociation of risk is a big reason why a spike in IPO offerings often precedes a stock correction.

One of the most worrisome aspects of the recent IPO surge is the sudden decrease in market volatility. Investors are clamoring for new stocks that haven't yet proved themselves and taking on excessive risk because that lack of volatility has left investors risk-hungry. With low volatility comes a predictable and often sideways trading market which is what we've seen the past several months. IPOs offer an opportunity for explosive growth in an environment where growth is sorely lacking.

A warning sign doesn't always mean imminent danger lies ahead

Despite the correlation between IPO releases and stock corrections, it doesn't always bode ill for the stock market. Even though June is on pace for a 15-year high, investors should look for perspective before taking IPOs as a negative signal.

We're already halfway into 2015 and less than 100 IPOs have actually been priced. If the same pace continued for the rest of the year, we would still lag behind the relatively hot IPO markets of 2013 and 2014 where more than 200 were issued in both years. Putting it into context even further - 1999 had 537 companies go public. Armed with that fact, it seems premature to say that the IPO market is in a bubble just yet.

According to the latest estimates, 179 companies have filed to go public for 2015. While many companies do file with the SEC, not all end up actually rolling out publicly. If June is the change in the tide for IPO issuances though, it could be an early warning signal that the market is getting overheated and headed for a corrective phase. It will be interesting to see how the IPO market progresses over the next couple of months as the Fed interest rate hike draws ever closer to reality.

 

Full Disclosures here.
This article is not intended as investment advice. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities.

 

This article is from Elite Wealth Management and is being posted with Elite Wealth Management’s permission. The views expressed in this article are solely those of the author and/or Elite Wealth Management and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

2015-07-01 13:28:29

Posted by
CME Group

Contributor

Futures

Employment Reports Could Impact Timing of Fed Rate Hike

Fed Fund Futures Pricing a December Move, While ADV Hits a 4-year High

At the June FOMC meeting, Chair Yellen announced a rate hike is likely in 2015 resulting in a surge in Fed Fund futures trading - with over 237,000 contracts traded on June 17, the largest volume day since June 2006.

Fed Funds Futures represent a direct reflection of collective marketplace insight regarding the future course of FOMC monetary policy – and there has been an increase in volume and open interest as firms prepare for a Fed rate hike.

  • June ADV is over 75,000 contracts
  • Open Interest is over 180% Year-Over-Year to 870,000+ contracts

Learn More about CME Fed Funds

 

Futures trading is not suitable for all investors, and involves risk of loss. Futures are a leverage instrument, and because only a percentage of a contract's value is required to trade, it is possible to lose more than the amount of money initially deposited for a futures product.

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Copyright © 2015 CME Group. All rights reserved.

 

This article is from CME Group and is being posted with CME Group’s permission. The views expressed in this article are solely those of the author and/or CME Group and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

2015-07-01 12:51:16

Posted by
Ron DeLegge
Founder
ETFguide
Contributor

Stocks

Shocking Proof that "Good" Investments Sometimes Start Out Bad

After analyzing and grading more than $100 million in investments using my Portfolio Report Card grading system, I’ve seen my fair share of good, bad, and ugly portfolios. But one question has haunted me: Do good investments always start out good? I discovered the answer to this incommodious question in a Report Card I recently did on a $26.9 million portfolio.

The table below shows just part of this investor’s portfolio. As you can see, the owner converted an $80,978 investment in Apple (AAPL) into $8.3 million and a $14,239 investment in Amgen (AMGN) into $3.2 million. Although he’s an outlier, let me be clear that he’s not an insider at either company and he has no firsthand experience in the technology or biotech field.

You’ll notice how his initial purchase of Apple’s stock happened in 1991 at a split-adjusted price of $1.57 per share. He bought more Apple in 1998 and then one final round in 2001, right when the entire world was distracted by the aftermath of 9/11. Lest I remind you, the first 10 years of his Apple investment was a complete bust because on paper, he was down -26% from his initial purchase price!

This real life example teaches us that good investments do sometimes start out bad. But since most investors lack the stamina, conviction, and audacity to allow their investments to blossom, they sadly never experience the sweet taste of success like this particular investor. 

The other lesson is that buying out-of-favor assets and patiently waiting for them to increase in value is a proven recipe for wealth building. It’s worth noting when this particular investor first purchased Apple in 1991, it was the ugly duckling of the technology space. Back then Microsoft, Dell Computer, Compaq, Intel, and Cisco Systems were the stocks to own.

By the way, this same ultra-contrarian approach can be applied to ETF investing in out-of-favor sectors and assets. It’s a strategy we’ve used quite successfully at ETFguide. (This article appeared in the June 2015 issue of the ETF Profit Strategy Newsletter.)   

 

Interactive Brokers clients can learn more about the Income Mix Portfolio at ETFguide by signing up for a free trial in Account Management. Learn more about ETFguide on the IB website.

The ETF Profit Strategy Newsletter provides detailed analysis on major market trends, and which long/short ETFs offer the best profit potential. Investments are carefully selected from a universe of more than 2,000 ETFs and each issue contains our proprietary global equity map, our mega-investment theme report, and a complete rundown of yield and performance data for major ETFs. Subscribers also get access to our Weekly ETF Picks and Technical Forecast.

 

This article is from ETFguide and is being posted with ETFguide’s permission. The views expressed in this article are solely those of the author and/or ETFguide and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

2015-07-01 11:56:00

Posted by
Erik Norland
Executive Director and Senior Economist
CME Group
Contributor

Macro

India: The Next China?

India’s economy, which grew at a sizzling 8-10% annual rate from 2005 to 2011 – except for a break during the 2008-2009 global financial crisis – has settled into a significantly slower pace of expansion. While the 4-6% growth rate achieved since 2012 is still impressive compared to most of the world’s economies, the pace is disappointing for a country that aspires to become an economic superpower on the scale of neighboring China (Figure 1). In late 2014 and early 2015 India’s economy showed signs of renewed growth that might point to stronger performance ahead. However, the composition of India’s resurgence has shown a deterioration in quality. Improving that quality won’t be easy without significant reforms that Prime Minister Narendra Modi’s government hasn’t yet been able to enact.

While the composition of growth and the external sector look worrisome, it’s not all bad with India’s economy: inflation has come down and India has thus far avoided the downturn hitting Russia, Brazil and other commodity-producing countries. Moreover, India’s relatively lower level of private sector debt and comparatively faster growing population may lead it to outperform China, which has dominated growth among emerging economies.

To read the full report from Erik Norland, please click here.

 

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

 

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

This article is from CME Group and is being posted with CME Group’s permission. The views expressed in this article are solely those of the author and/or CME Group and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

2015-07-01 11:21:56

Posted by
Allen Jackson
New Constructs, LLC
Contributor

Stocks

Secure Your Portfolio with a Leader in Cyber Security

What do Target, Home Depot, J.P. Morgan and Sony have in common? They are all recent victims of a cyber attack. When companies this big are victims, it seems no sector, network, or system is immune to these threats. The result is that companies are investing record amounts to protect themselves from system breaches. Investors can profit from this trend by investing in a global leader in cyber security. This week’s stock pick is Check Point Software Technologies (CHKP).

The Leader In an Expanding Industry

Check Point continues to be the worldwide leader in market share for Firewall Equipment and currently provides security systems for 98% of the Fortune 500 and over 100,000 businesses in total. After reporting its 1Q15 results, despite continued strength in revenue and profit growth, shares are actually down nearly 3%. With a growing user base, rapidly expanding industry, and product improvements on the horizon, Check Point shares don’t get the valuation they deserve.

A SAAS Model That Is Highly Profitable

Check Point has grown revenues by 11% compounded annually over the past ten years in large part due to its combined hardware and software based business model. In addition to traditional hardware sales, Check Point creates recurring revenues through its software as a service (SAAS) business model.

The real determinant of a great company is if management can translate that revenue growth into profit. Over the past decade, Check Point has grown after-tax profit (NOPAT) by 14% compounded annually, even faster than revenue. The consistent profit growth is a testament to Check Point’s efficient operations. Since 2010, Check Point has achieved gross margins above 85% each year, and 88% in 2014. Check Point’s pre-tax (NOPBT) margin has been upwards of 50% over this time period and was 54% in 2014.

Check Point currently earns a return on invested capital (ROIC) of 180%, up from 37% in 2008. The company has generated over $2 billion in free cash flow since 2011. With the large amount of free cash flow, Check Point has ample ability to continue its $1.5 billion share repurchase program that was approved in early 2015 and continue to invest in developing market-leading solutions.

Building for the Future

Investors fear the rapid pace of cyber attacks will make current security providers obsolete. What they fail to realize is that Check Point has faced strong competitive forces since its founding in 1993. Competing against large tech firms to smaller startups, Check Point has maintained its market leading position and has continued to innovate along the way.

The key differentiator for Check Point is its robust and flexible product offerings. As the largest pure play security vendor in the world, the company can offer a higher degree of customization and focus to its clients.

Smaller peers such as Palo Alto networks, although growing rapidly, cannot compete with the multi-layered line of defense from Check Point. In addition, Check Point recently acquired two smaller firms to further their security offerings. Hyperwise is considered to be a direct competitor to Palo Alto’s security prevention platform and will be integrated into Check Point’s existing platforms. Lacoon Mobile on the other hand, provides security for iOS and Android operating systems that can be integrated into a company’s existing security infrastructure.

Check Point is ensuring that it can provide solutions across the entire IT security value chain in addition to providing market leading firewall equipment.

When It Pays to Be First

Check Point has strong advantages over its competitors across many key metrics. Many of Check Point’s competitors are either newer entrants into the market, or smaller businesses that must spend large amounts to attract clients and build out system operations. As shown in Figure 1, Check Point derives much greater returns on the capital invested than its competitors. Being more profitable than its competitors gives Checkpoint pricing power and staying power for developing market-leading solutions.

Figure 1: Check Point Operates Above the Rest

Sources: New Constructs, LLC and company filings

Impact of Footnotes Adjustments and Forensic Accounting

To reveal the true economic performance of Check Point, we look deeper into the company’s 10-K reports. By removing nearly $35 million in reported non-operating income, largely in the form of interest income, and $12 million in tax adjustments, we see that Check Point’s NOPAT was lower than GAAP net income in 2013.

2014’s NOPAT was also below GAAP net income but after the removal of non-operating items we see that NOPAT grew 5% year over year while reported net income only grew 1% in 2014. Without an understanding of the accounting adjustments required to derive the true recurring cash flows of a business, investors would have underestimated Checkpoint’s rate of growth.

Invest Now Before Check Point’s True Value is Realized

At its current price of $84/share, Check Point has a price to economic book value (PEBV) ratio of 1.3. This ratio implies the market expects Check Point’s NOPAT to grow by only 30% from the current level over its remaining life. While 30% NOPAT growth is nothing to balk at, after growing NOPAT by 14% compounded annually for the past decade, it seems overly pessimistic to expect Check Point to increase NOPAT by only 30% over the remaining life of the business.

Given Check Point’s market leading position and strong fundamentals the company is undervalued. If we give Check Point credit for 9% compounded annual NOPAT growth for the next decade, well below what it achieved in the preceding decade, the stock is worth $109/share today. This price represents a 31% upside from current levels.

Disclosure: David Trainer owns CHKP.

David Trainer, Allen L. Jackson, and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

 

About New Constructs

We find it. You benefit. Cutting-edge technology enables us to scale our forensics accounting expertise across 3000+ stocks. We shine a light in the dark corners of SEC filings so our clients can make safer, more informed decisions.

Our stock rating methodology instantly informs you of the quality of the business and the fairness of the stock’s valuation. We do the diligence on earnings quality and valuation so you don’t have to.

In-depth risk/reward analysis underpins our stock rating. Our stock rating methodology grades every stock according to what we believe are the 5 most important criteria for assessing the quality of a stock. Each grade reflects the balance of potential risk and reward of buying that stock. Our analysis results in the 5 ratings described below. Very Attractive and Attractive correspond to a "Buy" rating, Very Dangerous and Dangerous correspond to a "Sell" rating, while Neutral corresponds to a "Hold" rating.

Cutting-edge technology enables us to scale our forensics accounting expertise so that we can cover enough stocks to cover the ETFs that hold them as well. Learn more about New Constructs. Get a free trial. See what Barron’s has to say about our research. Cutting-edge technology enables us to scale our forensics accounting expertise so that we can cover enough stocks to cover the ETFs that hold them as well. Learn more about New Constructs. Get a free trial. See what Barron’s has to say about our research.
 

This article is from New Constructs, LLC and is being posted with New Constructs, LLC’s permission. The views expressed in this article are solely those of the author and/or New Constructs, LLC and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

2015-07-01 10:22:58

Posted by
Daniel Beckerman
President
Beckerman Institutional
Contributor

Fixed Income

Navigating the bond market maze: Smart bond strategies to check interest rate risk

Many investors own bonds as part of their overall portfolio. Bonds are often thought of as the safety portion or “anchor” to an investment portfolio. However, bonds overall are in a precarious situation as rates have remained quite low, given the inverse relationship between bonds and rates. Now that the US Federal Reserve has increasingly been talking about when to raise rates, this issue is becoming much more prominent.

Bad Bet

Low interest rates have created an asymmetrical risk situation, making bonds (overall) a particularly bad bet at the moment. This is because interest rates have a lot of room to increase over time, whereas there is not much room for rates to decrease. For every one percent move up in interest rates, treasuries could lose as much as -8.5% (for the 10-year Treasury bond) and -17% or more (for the 30-year bond).

Because bonds are an important piece of overall asset allocation, we have identified some strategies that we believe can help in reducing the interest rate risk associated with fixed income.

Buy Short Term Bonds

Look to minimize duration in a bond portfolio in order to limit interest rate risk. Duration measures sensitivity to interest rate changes. It is defined based on the number of years it takes for the lender to recoup their investment.

Generally investors should keep their duration relatively low in preparation for rising interest rates. If I am invested in a short term bond such as a two year US government note, it can still lose value if short-term rates go up. However, the downside is relatively limited. Once the two year period is up, I can reinvest my principle at the prevailing (potentially) higher interest rate.

Floating Rate Bonds

These are bonds that “float” or adjust their interest payments based on changes in interest rates. There are some risks with these. Many of these bonds are subject to default risk as much of the sector is comprised of below investment grade bonds. During the financial crisis, for example, the Barclays Aggregate Bond market index was up just over 5% during the financial crisis in 2008. Floating rate loans on the other hand were negative.

Tactical Advantage

When rates are rising the floating rate bond sector gets exposed to the risk of adverse selection. This is because borrowers will tend to want to pay off their floating rate debt in exchange for a fixed loan, in order to manage the risk of increasing loan payments. This leaves more low quality bonds to comprise the category. Despite these risks, floating rate bonds provide a big tactical advantage when rates are rising. In contrast to most bonds, these become increasingly valuable as rates go up.

Buy International Bonds

There is a good possibility that the US will face rising interest rates in the near future, however, many economies have not experienced the economic strength of the US in recent years. Whereas, our country is in the process of exiting “quantitative easing” or stimulus, areas such as Europe and Japan are still trying to juice their economies and do not appear close to raising interest rates anytime in the near future. We believe international bonds may provide a nice hedge against potentially rising rates here at home.

Buy Unconstrained Bonds

Another option is to look for unconstrained bond managers and focus on those that are able to demonstrate a plan for potentially rising rates. Many of them will buy bonds that they think are undervalued and then short or bet against areas of the bond market that they are bearish on. Unconstrained bond managers (as the name implies) indicates that the managers can invest wherever they like in response to bond market risks and opportunity.

Underweight Bonds

Many investors have a certain amount of wiggle room in terms of how much they are willing to invest in bonds within a certain asset allocation. It makes sense for many investors to stay on the low end of their bond allocation if rates begin to rise. Investors can look to increase their exposure to other assets that are lesser correlated to stocks in lieu of bonds. Alternative categories such as Managed Futures or Merger Arbitrage have little correlation with the stock market.

False Premise

Many investors falsely believe that rising interest rates mean that the stock market will crash or correct. The argument that I often hear is that rising rates is the reverse of stimulus and can only mean trouble for the stock market. This is not necessarily accurate.

History Lesson

If you look at the three periods in recent history when interest rates were rising (1994-95, 1999-00, & 2004-06), the Federal Funds rate was rising yet the stock market produced positive performance. That being said, there are sectors of the market that I believe investors should steer away from in a rising interest rate environment.

Utilities and Real Estate

I would argue that utilities and real estate are particularly vulnerable to rising rates. Their valuations have been bid up to historically high levels due to the hunt for yield in a low interest rate world. Vanguard’s Real Estate ETF (VNQ), for example, sports a PE ratio of over 30.

If you look at these two sectors they have become fairly correlated to long-term bonds, which get whacked in a rising rate environment. Last year the ETF TLT (iShares 20+ year Bonds) was up 27.3% while VNQ (Vanguard Real Estate ETF) was up 30.6% and VPU (Vanguard Utilities ETF) was up 26.99%.

Within the stock market I would argue that it makes sense for investors to look to invest in areas that are less interest rate sensitive such as technology and healthcare.
 

The investments discussed are held in client accounts as of June 16, 2015. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.

 

Daniel Beckerman is President of Beckerman Institutional, a registered investment advisor in Oakhurst, New Jersey. He is also Portfolio Manager of the Beckerman Institutional Asset Allocation portfolio on Covestor. Covestor is an online investing marketplace and a division of Interactive Brokers Group.

 

This article is from Beckerman Institutional and is being posted with Beckerman Institutional’s permission. The views expressed in this article are solely those of the author and/or Beckerman Institutional and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

2015-07-01 09:27:59

Posted by
Darren Chu, CFA
Founder
Tradable Patterns
Contributor

Technical Analysis

Cotton (CT) Retesting Daily Chart Upchannel Resistance

Cotton (CT) initially retraced 61.8% of the week long rally after hitting upchannel resistance (on the daily/4hr charts) only to bounce back and close slightly higher yesterday.  CT is now retesting the same upchannel resistance and approaching a longer term upchannel resistance (on the weekly chart).  Weekly, daily and 4hr RSI, Stochastics and MACD are all rallying except for the weekly RSI and Stochastics which are beginning to consolidate.  I am flat CT now and will look to go long intraday today in the .65-.67 range.
 

For more information about Tradable Patterns, click here.

 
Cotton (ICE CT Dec15) Weekly/Daily/4hr/Hourly
 
 

 

Tradable Patterns was launched to demonstrate that the patterns recurring in liquid futures, spot FX and equity CFD markets can be traded consistently profitably. Tradable Patterns’ daily newsletter (blog) provides technical analysis on a subset of ten to twelve CME/ICE/Eurex futures (commodities, equity indices, interest rates), spot FX and US equity markets, which it considers worth monitoring for the day/week for trend reversal or continuation. For less experienced traders, tutorials and workshops are offered online and throughout Southeast Asia.

 

This article is from Tradable Patterns and is being posted with Tradable Patterns’ permission. The views expressed in this article are solely those of the author and/or Tradable Patterns and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

 

2015-07-01 09:24:30

Posted by
Darren Chu, CFA
Founder
Tradable Patterns
Contributor

Technical Analysis

Natural Gas (NG) Nearing End of Daily Chart Symmetrical Triangle

Natural Gas (NG) closed slightly higher yesterday after an initial dip, and is nearing the end of a symmetrical triangle (on the daily chart) and approaching its resistance.  Weekly and 4hr RSI, Stochastics and MACD are all rallying, although with the situation in Greece in flux, and weekly storage on Thursday, the daily momentum indicators are settling into a fairly neutral range.  I am flat NG now after having traded it on the long side yesterday and will look to go long intraday today in the 2.78-2.82 range.
 

For more information about Tradable Patterns, click here.

 
Natural Gas (CME NG Aug15) Weekly/Daily/4hr/Hourly
 
 

 

Tradable Patterns was launched to demonstrate that the patterns recurring in liquid futures, spot FX and equity CFD markets can be traded consistently profitably. Tradable Patterns’ daily newsletter (blog) provides technical analysis on a subset of ten to twelve CME/ICE/Eurex futures (commodities, equity indices, interest rates), spot FX and US equity markets, which it considers worth monitoring for the day/week for trend reversal or continuation. For less experienced traders, tutorials and workshops are offered online and throughout Southeast Asia.

 

This article is from Tradable Patterns and is being posted with Tradable Patterns’ permission. The views expressed in this article are solely those of the author and/or Tradable Patterns and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

 

2015-07-01 09:24:19

Posted by
Darren Chu, CFA
Founder
Tradable Patterns
Contributor

Technical Analysis

Raw Sugar (SB) Testing Daily Chart Downchannel Resistance

Raw Sugar (SB) surged higher yesterday, and is now testing downchannel resistance (on the daily chart) and approaching descending wedge resistance (on the weekly chart).  Weekly, daily and 4hr RSI, Stochastics and MACD are all rallying except for the weekly MACD which is just positively crossing.  I am flat SB now and will look to go long today in the .12-.123 range.
 

For more information about Tradable Patterns, click here.

Raw Sugar (ICE SB Oct15) Weekly/Daily/4hr/Hourly
 
 
 
Tradable Patterns was launched to demonstrate that the patterns recurring in liquid futures, spot FX and equity CFD markets can be traded consistently profitably. Tradable Patterns’ daily newsletter (blog) provides technical analysis on a subset of ten to twelve CME/ICE/Eurex futures (commodities, equity indices, interest rates), spot FX and US equity markets, which it considers worth monitoring for the day/week for trend reversal or continuation. For less experienced traders, tutorials and workshops are offered online and throughout Southeast Asia.

 

This article is from Tradable Patterns and is being posted with Tradable Patterns’ permission. The views expressed in this article are solely those of the author and/or Tradable Patterns and IB is not endorsing or recommending any investment or trading discussed in the article. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

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