Welcome! Today we’re going to be covering the current bull market, the fundamental differences between ETF’s and ETN’s, and how it all affects your personal portfolio. Let’s get started.
The stock market remains in a bull market but temporarily is in a correction. The bond market is in a bear market with interest rates rising and existing bond prices falling. No recession is in sight and all portfolios remain fully invested.
Home prices have continued to rise rapidly across the country. The S&P CoreLogic Case-Shiller National Home Price Index rose 6.3% in December 2017 compared to December 2016.
US consumer confidence rose to its highest level in February 2018. The Conference Board said its measure of US consumer confidence increased to 130.8 in February from 124.3 in January 2018.
The revised estimate for GDP for the 4th quarter of 2017 was 2.5%. GDP growth for the year 2017 was 2.5% compared to 1.8% for 2016.
On February 5, the market dropped 4.1% as volatility rocketed higher. Ouch! On February 8 the stock market established the start of a market correction (down at least 10% from a recent high) on a closing basis. On February 9, an intraday low was reached even though the market closed up for the day.
OK, so everyone please put your feet up and relax. This is just another correction. Corrections do not end bull markets. During this bull market, which began in March 2009, we have had a correction in each of 2010, 2011, 2015 and 2016. Now another correction has begun. It will probably last 2 to 4 months following the all-time market high on January 26. This is the time to demonstrate courage and patience, as required of every stock market investor.
On February 5, the average daily flow of money inside 2 million 401K investor’s accounts all across the country from stock funds to cash or to bond funds was 12 times higher than normal. On Tuesday, February 6, it was again four times higher.
What was everyone doing? They were selling low. Someone important once said, the only way to make money is to buy low and sell high. Looks like millions of investors have this backwards. We hope you are not one of these investors.
This story will help make the point. So the week before Christmas a female shopper goes to a department store to buy a couple pairs of wool slacks. She finds what she is looking for, and to her surprise, the clothes rack is labeled “30% OFF.” Does she yell out, “No, No, No! I want to buy high! I want to pay the full price!” Of course not; she smiles and congratulates herself on buying low.
When shopping, everyone knows it is better to buy low. So, why do the same people like to sell low and buy high with their investments? Because they are buying and selling within their portfolios based on their emotions. If you don’t know what to do on high volatility days, call Mark at Lorenz Financial.
ETF’s Can Be Great, But What About ETN’s?
ETFs, or Exchange Traded Funds, mostly involve various stock and bond markets. Think of them as a mutual fund that trades during the day. They are no-load but they have an annual expense ratio just like regular mutual funds. Because they are bought and sold on a stock exchange, they can have a brokerage charge and perhaps a transaction fee. Ask your broker, “How much does it costs to trade ETFs?” At Lorenz Financial, the cost to buy or sell a mutual fund or ETF is zero.
There are no guarantees with an ETF, but the products they hold support their price. For example, VOO is a large ETF that mimics the price movement of the 500 largest US stocks in the S&P 500 Index. When you buy VOO, you are buying a piece of every stock in that index.
ETNs, or Exchange Traded Notes, are a completely different investment vehicle. ETNs trade on an exchange and are a debt obligation of a large bank. ETN payment terms are linked to the performance of an index or benchmark, representing the ETN’s investment objective. ETNs are a complex structured product that include many risks for investors and can result in the entire loss of the investment.
Here is one of the worst examples of an ETN. Its name is VelocityShares Daily Inverse VIX. Symbol is XIV. VIX is the CBOE Volatility Index of the stock market. A low number for the VIX has been 9 or 10, but recently it approached 50. Because this ETN performs the inverse of the VIX, as volatility goes up, the VIX goes up but this ETN goes down. See the 7-day chart below of the ETN, XIV.
The 52-week price range of XIV is $146.44 down to $5.10. Yes a 94% loss, mostly on Feb 5! ETNs are much more complicated than what is explained here. The point is, press on buying large ETFs such as VOO, but please stay 100% away from ETNs. ETNs are primarily designed to be a profit center for banks. So in the ETF and ETN world, what should an investor avoid?
- Stay away from all ETNs!
- Avoid all Exchange Traded Products such as exchange-traded commodity funds.
- Stay away from all Inverse ETFs. (As the market goes up, the ETF drops and vice versa.)
- Avoid all 2X or 3X leveraged ETFs. (If the market goes up 1%, a 2X ETF will go up 2% and a 3X ETF will go up 3%, or go down in a similar leveraged fashion.)
- For a given market, always look for the ETF with a lower annual cost. Some have very high annual expense ratios as compared to others for the same index.
- For liquidity reasons, only buy an ETF that trades at least one million shares a day.
If you need assistance picking out an ETF for your portfolio, call Mark Lorenz at Lorenz Financial.
Recommended Action for Your Stock Portfolio
All portfolios remain fully invested. There should be no selling during a correction. A buy signal might develop if this current short-term rally fails and the market drops to re-test its recent low of February 8 & 9. If this happens, Lorenz Financial will make the appropriate announcement.
The bear market in bonds continues. Investors should definitely not hold any long-term bonds or long-term bond funds. Long-term is duration greater than 7 years.
The current economic expansion is on track to become the longest on record. All of our real time economic indicators suggest our forecast for economic growth to continue for the foreseeable future. Fed forecasts indicate real GDP growth is increasing at a pace between 2.6% and 3.1%. There are no signs of a recession.
On her last day in office, Chair of the Federal Reserve Janet Yellen announced the Fed was forcing Wells Fargo to oust board members and limit the bank’s growth until the bank improves its governance and controls.
Yellen said, “We can not tolerate pervasive and persistent misconduct at any bank and the consumers harmed by Wells Fargo expect that robust and comprehensive reforms will be put in place to make certain that the abuses do not occur again”. Lorenz Financial recommends anyone with a bank account, credit card, home equity line of credit, etc, with Wells Fargo, to immediately close all accounts.
The Federal Open Market Committee (FOMC) is scheduled to meet on March 20 and 21. We expect FOMC members will vote to increase the federal funds rate to a target range of 1.5% to 1.75%. Incoming economic data has been inline with the Fed’s projections. The unemployment data has stabilized at 4.1% for the past four months and remains below the Fed’s target.
To pull the US economy out of the 2008-09 Great Recession, the Federal Reserve significantly lowered short-term and long-term interest rates. Now that the world’s economies are doing much better, both short-term and long-term rates are on the increase. Starting in December 2015, the Federal Funds short-term rate has been increased five times by the Fed resulting in the current rate range of 1.25% to 1.50%. We expect the Fed will raise this rate 0.25% at their March meeting.
The Fed purchased $4 trillion in Treasury & mortgage backed long-term bonds following the Great Recession to lower long-term interest rates. In the 4th qtr 2017, the Fed started selling off those bonds at the rate of $10B per month. During 2018, the rate of bond sales will increase $10B per quarter. Therefore, the 2018 1st qtr selling rate will be $20B per month and the 2018 4th qtr selling rate will be $50B.
The Bureau of Economic Analysis announced the latest inflation numbers as per the Personal Consumption Expenditure (PCE). For three months, these inflation numbers are unchanged. Headline PCE was up 1.70% year over year in January. Core PCE, which excludes food and energy, was up 1.5% year over year. The Fed’s target is 2% for Core PCE. Inflation is definitely stable and under control.
As measured by the difference between Treasury bond yields and TIPS yield, inflation expectations can be calculated. See the results below.
Treasury Bond Maturities & Inflation Expectations
- 5 Year – 2.04%
- 10 Year – 2.12%
- 30 Year – 2.14%
Recommended Action for Your Bond Portfolio
Our bond market investments remain unchanged. We are investing only in short-term investment-grade bond funds; intermediate-term investment-grade bond funds; and short-term, high-yield bond funds. We are not recommending any long-term bonds or long-term bond funds. Muni bond funds are not recommended at this time due to the risk of some US cities going bankrupt. Treasury bond funds are not recommended at this time due to their low yield.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS