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EWM Team

Sep 12
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Real Estate is officially a new Sector

By Uncategorized

In November 2014, S&P Dow Jones Indices and MSCI Inc. issued a press release announcing the creation of an 11th sector under the Global Classification Standard (GICS) structure. That sector, Real Estate, was implemented last week—marking the first time the GICS structure has been updated since it was created in 1999. Although the impact of this decision will play out over time, it now is clear that Real Estate Investment Trusts (REITs) have found their own home.

Formerly housed under Financials, the Real Estate sector will include equity REITs (REITs that own physical property), as well as real estate management and development companies. Mortgage REITs (REITs that comprise mortgage-backed securities) will remain within the Financials sector. The most immediate impact of this decision is its effect on various benchmarks widely used by investors. For example, the S&P 500 will include the Real Estate sector in its asset allocation beginning September 16. This will result in a 3.23% weight for Real Estate within the S&P 500 moving forward—which is greater than both Telecommunication Services and Materials. The market weight for Financials, on the other hand, will dip from 15.75% to 12.52%, and will rank below Healthcare as the second-largest sector within the index. The impact on many smaller cap indices—in which REITs make up a greater percentage of publicly-traded companies—is likely to be even more profound.

Asset managers undoubtedly will be forced to rehash how they both view the Real Estate sector and implement REITs in their portfolios. Historically, many asset managers and investors alike have underweighted REITs, since they were not deliberately carved out within their benchmarks. That is, a benchmark-aware investor could avoid REITs altogether by investing in enough financial stocks to remain sector-neutral. As asset managers who once underweighted real estate in portfolios begin to change their tune, demand for REITS could increase significantly, and potentially be a boon for the sector as a whole.

Whereas the increase in demand seems a foregone conclusion, investors should remain wary. Adding the Real Estate sector to the major indices also makes REITs far more visible than when they were hidden within Financials. Analysts and stock pickers often neglected REITs because they failed to understand that traditional accounting metrics do not accurately reflect REIT valuations. Ratios such as price-to-earnings (P/E) or earnings per share (EPS) do not apply nearly as well as either price-to-funds from operations (FFO) or the capitalization rate for REITS. This increased visibility is likely to result in increased scrutiny as analysts and portfolio managers are forced to become more familiar with REITs. As Wall Street shifts its focus to the new Real Estate sector, the market for REIT shares could become more efficient—materially changing the risk/return dynamics. For a market area that has outperformed the broader equity market dramatically over the early part of the 21st century, it’s anyone’s guess as to what this could mean moving forward.

At the end of the day, we can draw one conclusion for certain:  Real estate deserves a seat at the table within in a well-diversified portfolio. The asset class has grown tremendously over the past quarter of a century—breaching the $1 Trillion mark in total equity market capitalization in recent months. S&P and MSCI have responded by offering real estate its own home for the first time.

 

Jun 02
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Mary Meeker’s Internet Trends Report 2016

By Venture Capital

Here are some highlights from the above report:

  • India is the one country where internet usage is growing, up 40 percent compared with 33 percent a year ago. India passed the U.S. to become the No. 2 global market behind China in 2015.
  • The Asia Pacific region represented 52 percent of smartphone users globally in 2015. The rapid growth in recent years has begun to slow, dropping to 23 percent in 2015 from 35 percent in 2014.
  • North America, Europe, and Japan represented 63 percent of global GDP in 1985. By 2015, their contribution dropped to 29 percent. China and emerging markets in Asia represented 63 percent of global GDP last year.
  • Online advertising is still not very effective. Advertisers are spending an outsize amount on legacy media.
  • Global birth rates are down 39 percent since 1960. So where will technology growth come from? Who knows, but at least there’s this: Global life expectancy is up 36 percent since 1960.

Meeker co-authored the first Internet Report in 1995 as an analyst at Morgan Stanley. A copy of the report can be downloaded here: Internet Trends Report 2016.

Apr 15
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Interest Rates and the Stock Market

By Uncategorized

Correlations can be a misleading measure of the interaction between economic variables. Here, we take a look at interest rates and the stock market.

Consider the cause-and-effect chains that exist between the economy, interest rates, and the stock market. Economic growth should in general be good news for the stock market, and it should also generally mean upward pressure on interest rates. A weak economy should be the opposite.

However, the stock market tends to welcome news of a cut in rates, and dislike increases.

This creates a slightly complex picture as regards the interaction between interest rates and the stock market. On the one hand, the direct connection might be expected to lead to a negative correlation; falling rates being good for markets. On the other hand, the way that the broader economic picture affects each would point to a positive correlation; when the economy is strong, we expect rising rates and strong markets.

In isolation, a rate increase can be seen as bad news for the market, but as a symptom of a strong economy it can be seen as good news. These relationships aren’t really that confusing, but they become so if we try to reduce them to a single correlation number.

Evidence of the nuanced relationship can be found in historical returns patterns as shown in the table below:  U.S equities did well when rates rose slowly (i.e. rate less than 1% per year), but not so well when rates rose rapidly (perhaps because rapid increases are often associated with economic distress); meanwhile, when rates fell, U.S. equities did better when they fell rapidly, and not so well when they fell slowly.

Annualized returns on U.S. equities in different interest rate environments (This analysis covered the period January 1970-September 2013).

Source: Russell Investments (Madden & Totten (2014) When rates rise, do stocks fall?)

U.S. Equity Returns in Different Interest Rate Environments

Apr 15
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Are Emerging Markets coming back for good?

By Market Outlook

Emerging markets (EM), one of the most unloved asset classes of the past few years, have recently proven to be a bright star in the market. As global equities posted another strong week (hitting fresh year-to-date highs across a number of markets), EM continued to strengthen. Its success thus far in 2016 raises a question on an asset class that has struggled for most of the past five years: Is EM finally back?

The EM asset class posted a great first quarter, gaining 5.7%, as measured by the MSCI Emerging Markets Index. Several EM markets did exceptionally well, with the MSCI Latin America and MSCI EM Eastern Europe indices posting advances of +19.1% and +15.0%, respectively. Higher commodity prices, combined with an improving investor risk appetite and dovish global central banks, as well as a weakening dollar, helped to fuel much of the rally. EM’s success this year has been a great trend reversal of losses in the past three calendar years, including a -14.9% decline in 2015.

Its struggles have also negatively affected well-diversified portfolios, which have experienced a rally driven predominantly by US large cap over the past three years. Although we have definitely seen weak years recently for EM, it is important to remember that it can often lead by very wide margins. Over the 10-year decade from 2000-2009, in which the S&P 500 posted a loss of 9.1%, the MSCI Emerging Markets Index gained 154%, easily outpacing most major asset classes.

Despite its struggles of the past few years, strong reasons support owning EM, many of which investors have ignored. From a valuation perspective, MSCI Emerging Markets are trading at a forward P/E of 11.9, compared with 15.6 for the MSCI ACWI Index, and 17 for the S&P 500 Index, and also at a lower relative value from historical levels. From a diversification standpoint, owning EM helps portfolios gain access to countries that are experiencing growth at different times in their economic cycles, and often at higher rates, than the U.S.

Much of the negativity surrounding EM in 2015 was the Federal Reserve’s (Fed) looming rate hikes and the potential negative impact they would have on developing countries. Heading into 2016, the Fed was expected to raise rates four times this year. However, weaker-than-expected global economic data and indications from the Federal Open Market Committee (FOMC) suggest that we are still a ways off from the Fed’s moving aggressively to raise rates.

For the time being, EWM believes EM is definitely back. Whether the trend continues for investors buying into the story of a recently unloved asset class, or we see another reversal out of EM, only time will tell. One thing is certain: EM has posted outstanding gains in the past, often when other asset classes are struggling, and its success may mark the return of diversification.

Apr 13
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Today is the 10 year anniversary of the First Trust U.S. IPO ETF (FPX)

By ETF Related

At Endowment Wealth Management we have been recommending and using the above ETF since inception within our Private Equity and Risk Managed Models. We use this ETF as a proxy for public private equity, as these are considered newly listed. We are pleased with this ETF completing it’s 10 year of existence. Moreover, the performance over that time period has been impressive as well.

The IPOX 100 U.S. Index (that underlies this ETF) currently pools a total market capitalization of approximately USD 1.3 trillion. Since inception, the USD 585 milion ETF has returned +169.14% vs. +96.66% and +69.26% for the ETFs linked to the S&P 500 (SPY) Index and Russell 2000 (IWM) Index, respectively. The fund carries a 5 star rating from Morningstar.

The ETF tracks IPOX Schuster’s IPOX 100 U.S. Index (IPXO), benchmark for the largest and typically best performing U.S. IPOs and corporate Spin-offs “going public” over a 4-year rotational cycle. IPOX Schuster LLC (www.ipoxschuster.com), the Chicago-based innovative Financial Services Firm specializing in Financial Products Design related to Newly listed companies such as IPOs and corporate Spin-offs, is the creator and managed of this Index.

 

Apr 08
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Is the U.S. stock market fairly valued?

By Market Outlook

As the stock market pulled off another dramatic, V-shape turnaround, and the S&P 500 Index is once again within striking distance of its all-time high, the discussion has intensified as to whether or not the stock market is overvalued. Although valuation is never a good market-timing tool for short-term traders, price does matter, especially for long-term investors.

Much confusion exists on how to value the stock market. Different market commentators use various valuation measures, whether due to their diverse schools of thought or their dissimilar views that support their own interpretation of the market. For example, someone making a strong case for the market being grossly overvalued will use the most conservative earnings measures, such as normalized or inflation-adjusted earnings. On the other hand, those aspiring to convince the public that the market is cheap may rely on more “lenient”, or growth-oriented earnings measures, such as EBITDA or out-year earnings projections.

The stock market, and rightfully so, is the Price-to-NTM (next-twelve-month) consensus earnings estimate. For example, if the S&P 500 Index stands at 2000, and the NTM consensus earnings estimate is $120 per share, the stock market is valued at 16.7 times forward earnings.  This figure is slightly higher than the long-term average of approximately 15 times forward earnings.

Another widely used measure is Price-to-LTM (last-twelve-month) earnings. Since investing in the stock market is based on a company’s future earnings, this backward-looking measure is not considered relevant for decision making.  That is because it generally overstates how expensive the market is, as aggregate corporate earnings generally grow year after year.

It is worth mentioning that NTM consensus earnings are a recurring, pro-forma earnings estimate that excludes one-time items, such as write-downs or write-ups of asset values. These earnings are not strictly compliant with GAAP earnings, and pro-forma numbers do not have a good reputation (as some corporate crooks have abused them to mislead investors). But it is appropriate to use them for a stock market comprising hundreds, if not thousands, of companies, as one-time items of a host of them tend to offset each other, especially over time.

The S&P 500 Index consensus earnings estimate currently stands at $119 per share for 2016, and $135 per share for 2017. At the April 7 close of 2041.91, the Index trades at 17.2 times 2016 consensus earnings estimate. It is no doubt expensive, but if the 2017 estimate of $135 per share holds (+13.4% growth over 2016), the multiple will drop to just 15.1 at year end, based on the Index’s current level, and close to its long-term average. Of course, the consensus earnings estimates for 2016 and 2017 are anything but certain, since they are subject to frequent (if not significant) revisions as the macroeconomic environment evolves and companies update their earnings projections. They are imperfect, moving targets, but they do provide a rough estimate of how cheap or expensive the stock market is.

Mar 30
Love0

Quotes of the Day

By Quotes

Daniel Kahneman

It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.

Mark Twain

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

Mar 18
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A Macro View – Disappearing Dots Late in the Game

By Uncategorized

On Wednesday, the Federal Reserve (Fed) decided to maintain rates at their current level. More importantly, the Fed’s forward-looking expectations for rate increases (the dots) have gone from forecasting, just a couple of months ago, four rate increases in 2016, to yesterday’s forecast of just two rate increases. Interestingly enough, when the Fed raised rates in December, and targeted four increases for 2016, the futures market was predicting only a 50 bps rate rise this year, which is now what the Fed is targeting.

Currency markets quickly reacted, as the US dollar weakened, and other markets digested the news. Beyond the markets’ short term reaction, the slowdown in rate hikes raises concerns in the long term about how much dry powder the Fed and other central banks have at their disposal, given the state of the world economy. The truth is, economic growth has been slow since the massive injection of liquidity post the credit crisis, with annual GDP growth in America averaging around 2% since June of 2009. With so much liquidity injected into the system for so little an increase in economic output, the question becomes: What can central banks do if we enter another recession, considering rates are at record lows and trillions of dollars/euros/yen have already been printed?

Interestingly, Bank of America Merrill Lynch recently released a survey of fund managers in which 59% believe we are nearing the end of the game in terms of world economic growth. The signs are starting to emerge: a rapid decrease in commodity prices; concerns in the credit markets; and increased equity market volatility. Although asset prices quickly inflated after the credit crisis of 2008 due to a large injection of central bank liquidity, economic growth has not been as robust. This has exacerbated a number of social issues, ranging from increasing the wealth disparity (those with exposure to risky assets in 2009 have become much wealthier while those without continue to struggle) to reducing cash flow to older Americans who rely on “clipping coupons” to fund their retirement income needs. To paraphrase Winston Churchill, never has so much liquidity been used by so many central banks to benefit so few people. Economic growth has been slow, the wealth disparity has increased, and the reflation of asset prices has had the biggest benefit for those who already are wealthy.

In addition to these social ramifications, there is real concern over how much dry powder central banks have to fight the next recession. If we are nearing the end of economic growth, what options will they have to prop up the economy? This is a real concern, and is why some investment professionals have been lowering their long-term forecast of stock market growth. No matter how much liquidity you place in the system to re-inflate assets, stocks need economic growth for long-run appreciation. The question is: Will central banks have the tools to stimulate the economy if we slide into a recession? Many investors are concerned they will not, and that should concern us all.