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Five things investors should know as the recovery hits five years

investing-covestor

It has been nearly five years since the U.S. economy started its recovery after the harrowing experience of the financial crisis.

Long-term investors who had the courage to stick with U.S. stocks have been rewarded — from a price standpoint the S&P 500 has nearly tripled. And the index hasn’t suffered a 10% correction since 2011.

Of course, that’s all in the rearview mirror. The more important question is: Where do we go from here?

Stepping back, the U.S. economy started expanding in June 2009, and the length of the current recovery is above average since World War II, according to The Wall Street Journal. Yet the recovery has been notably weak as unemployment remains elevated and economic growth is relatively subdued.

So far this year, the S&P 500 is up slightly after rallying more than 30% in 2013.

Yet there are signs that investors may want to brace for a potentially bumpier ride as the economic recovery matures. Here are five things investors should keep in mind:

1. The wrong sectors are leading the way: The best-performing sector this year is utilities, which investors often favor when they’re playing defense. Also, investors have been putting money into other sectors of the market that tend to do well in the late stages of an economic recovery, such as energy. At the same time, they have turned away from sectors that tend to do well in the earlier phases, such as consumer discretionary, financials and technology, according J.C. Parets at All Star Charts.

2. Momentum is flagging: Until recently, investors had been bidding up speculative stocks with growth potential, but little or no current profits. Think social media stocks and biotech. “For much of this bull market, total returns have been driven by the low quality companies,” says Sam Stovall, chief equity strategist at S&P Capital IQ. “But when the seas start to get rough, investors will likely prefer those companies that offer a higher quality of earnings and greater stability of price returns.”

3. Some investors are worried that stocks are expensive: Overall stock valuations are a notoriously unreliable tool for trying to predict the market. That said, the cyclically adjusted price-to-earnings ratio (CAPE) developed by economist Robert Shiller is a common valuation metric for the U.S. stock market. The ratio is currently above its long-term average yet still well below the dot-com peak. Stocks don’t seem to be screaming “bubble,” but investors shouldn’t expect 30% returns every year.

4. The Fed is “tapering”: The Federal Reserve under new chief Janet Yellen is slowly but surely scaling back its bond purchases to the tune of about $10 billion a month. In other words, the central bank is reducing its economic stimulus as the recovery matures. That means that investors may focus more on the fundamentals, and less on what the Fed might do to support markets.

5. Seasonal patterns: Mid-term election years traditionally haven’t been great ones for investors. We’re also entering a seasonally weak period for the U.S. stock market — hence the adage “Sell in May and go away.”

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. All investments involve risk, the amount of which may vary significantly. Past performance is no guarantee of future results.

What’s driving the quiet rally in tax-free muni bonds

muni-bonds

Call it a stealth rally in municipal bonds. The asset class often favored by wealthy investors for its tax perks is bouncing back in 2014 despite well-publicized concerns over finances in Detroit and Puerto Rico.

Indeed, the $3.7 trillion municipal bond market may have a pulse after all. After years of strained state and city budgets, some spectacular defaults and muni bond fund outflows, things are finally starting to look up for this fixed-income sector.

The municipal bond market registered gains in March for the first time in six years and advanced about 3.8% for the first quarter. That’s the best quarterly showing since the first three months of 2009, when munis delivered a 4.4% return.

iShares National AMT-Free Muni Bond ETF (MUB)

MUB Chart

MUB data by YCharts

While it’s a little early to declare a sustained recovery, muni market conditions have clearly improved. That’s in stark contrast with expectations at the start of 2014, when Morgan Stanley forecast a 4% decline for munis, assuming that as interest rates rose these fixed-income securities would get clobbered.

Such dire predictions haven’t panned out. For starters, city and state finances are improving, making muni debt far more attractive than last year when bond defaults in Detroit and economic troubles in Puerto Rico prompted investors to flee the muni market.

Muni Outflows in 2013.png

Enticed by an improving economic outlook and the tax advantages of many muni bonds, investors are starting to return. The income thrown off by muni bonds is exempt from federal taxes.

Muni Bond Flows Recover.png

Pressure to cut local budgets is easing up, thanks to property-tax collections that are rising at the fastest clip since the U.S. housing market crash sent government revenue into a freefall.

In the last quarter of 2013, property-tax collections nationally rose to $182.8 billion, the highest mark in four years. If the tax flows into state and city coffers continue, muni bonds will be viewed as less risky by investors. In theory, that would drive down yields and increase bond prices.

Another positive development: The oversupply of muni paper seen in previous years seems to be easing. New issuances have leveled off and a tighter supply has also supported the price of munis.

Muni Supply Glut Eases.png

On April 11, Morgan Stanley revised its negative view on muni bonds in a note to clients. Citing improved tax receipts and investor interest, Morgan analysts concluded that “all in, the muni market appears to have a better tone to it than a month ago.”

Last November, Matthew Pierce, founder and portfolio manager at Island Light Capital, which manages the Income Portfolio on Covestor’s platform, made the case for munis before the recent rally.

“We use muni bonds in taxable accounts,” said Pierce. “We like the relative safety of muni bonds compared to corporates, and they can make sense when Treasury yields are low.”

DISCLAIMER: The investments discussed are held in client accounts as of March 31, 2013. 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. The information contained in this article is general in nature and not intended as specific advice. Neither Covestor Limited nor its representatives are engaged in rendering tax, accounting or legal advice. A qualified professional should be consulted regarding the effect of such considerations on the matters covered in this article.  Past performance is no guarantee of future results.

Spring cleaning: What to do with rotten eggs in your portfolio

nest-egg

Sometimes it feels like the whole personal-finance industry exists just to tell you what to buy. Yet knowing when and why to sell is just as important (if not more so), and investors can make costly mistakes if they don’t know how to dump the rotten eggs in their portfolio.

A big part of the problem is human nature. Really, who likes fessing up to a bad call? Behavioral finance experts such as Daniel Kahneman and Amos Tversky have documented in numerous studies how investor “loss aversion” can lead to irrational and money-losing mistakes.

In short, investors tend to feel the pain of loss more acutely than feel the pleasure of gain. Also, research published in 1998 by behavioral-finance professor Terrance Odean of the University of California, Berkeley, showed that individual investors are 50% more likely to sell a winning stock than a loser.

With a paper loss, it’s easier for investors to convince themselves the stock will come back and they’ll break even — if only they stick with it. Some will even double down and buy more.

Why? The depressed stock is a bargain relative to the original purchase price, investors often reason. This is a potentially dangerous game.

Overcoming the loss aversion syndrome requires stepping back, letting go of one’s pride and doing some dispassionate analysis.

One way to tackle the problem, suggests Mark Hulbert with The Wall Street Journal, is to “subject your stocks to the same valuation criteria that you used when initially deciding to purchase them.” If you bought a stock because it was outperforming its peers and had a lower price/earnings ratio, then ask yourself if that is still the case. If not, and the stock is tanking, it may be time to sell.

Biting the bullet on a stock that has significantly lagged the market over the past 12 months is another potential approach. Michael Sincere at MarketWatch suggests cutting lose a stock once it declines a certain percentage.

Morningstar StockInvestor editor Matt Coffina suggests remembering that any investment represents a choice among competing alternatives. As market conditions change, so can the relative attractiveness of your holding. Here’s his take:

“Every investment decision is relative. So, when you decide to own one stock, you’re also deciding not to own any number of other stocks, cash, bonds, options, or whatever it is. If we have a better opportunity, then that is the best time to sell and put that capital to work in something better.”

There are also some tax reasons to cut loose a trade gone bad. If you hold the stock in a taxable account, you may be able to use tax-loss harvesting to reduce the tax liability on capital gains elsewhere in the portfolio.

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Neither Covestor Limited nor its representatives are engaged in rendering tax, accounting or legal advice. A qualified professional should be consulted regarding the effect of such considerations on the matters covered in this article. Past performance is no guarantee of future results.

The best-performing sector of 2014 may surprise you

utilities

Many investors were bearish on utilities stocks heading into this year after the sector lagged the S&P 500 in 2013. Expectations of rising interest rates and continued risk-on sentiment were key components of the bearish thesis, but that hasn’t exactly happened.

Utilities Select Sector SPDR Fund (XLU) is actually the best performer among the nine major U.S. sectors so far this year — and it isn’t even close.

The utilities ETF is up more than 11% for the year-to-date period, and was actually rising to new all-time highs on Tuesday amid weakness in the overall market.

utilities-etf.png

The outperformance of the utilities sector isn’t something that the bulls want to see. Utilities are seen as a defensive sector that investors tend to flock to during times of heightened uncertainty in the market. The strength of utilities stocks also suggests interest rates could be heading lower, not higher.

The chart below shows the relative performance of the utilities versus the S&P 500, and the sector’s recent strength.

utilities-xlu.png

Meanwhile, the underperformance of consumer cyclical stocks is another worrying sign for the health of the overall market and the broad economy.

Consumer Discretionary Select Sector SPDR ETF (XLY)  is the worst performer of the nine major sectors so far this year with a loss of nearly 6%. The relative performance chart below illustrates this fact.

consumer-discretionary.png

Finally, the recent outperformance of another defensive sector, Consumer Staples Select Sector SPDR ETF (XLP), suggests that investors are moving more toward a risk-off posture.

Photo credit: Matthew Youngberg via Flickr Creative Commons.

DISCLAIMER: The investments discussed are held in client accounts as of January 31, 2013. 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. Past performance is no guarantee of future results.

Smartphones: Like cigarettes, only better

smartphones

By Barry Randall

Pop Quiz: What fits in your pocket, annoys others not partaking, is addictive, and costs more every day?

If you answered cigarettes, you’re right. But another correct answer is smartphones.

We’re not the first ones to make this comparison. But from an investment point of view, it’s useful.

The similarities between smartphones and cigarettes came to mind recently. I was reading a Wall Street Journal article describing that while the conventional wisdom is that aggressive competitive moves by T-Mobile (TMUS) and Sprint (S) ought to be driving prices down, mobile-phone bills continue to climb. According to the story, the average monthly revenue per postpaid user across the U.S. wireless-service industry has climbed from $55.80 in the first quarter of 2010 to $61.15 at the end of 2013. That’s a nearly 10% increase.

What other technology-based service or product has risen in price during that time? Cable TV? Nope, going down with “cord cutters.” Tablets? Not with Samsung (SSNLF) carving into Apple’s (AAPL) market share. Basic DRAM memory? On a price-per-gigabyte basis, DRAM prices have been halved in the last four years.

For our firm’s flagship tech portfolio, we typically follow the lead of our quantitative model, which ignores the specifics of a particular company’s product or service, focusing instead on its financial performance and market share trends.

But I admit I was surprised recently to observe that we own no less than six wireless service providers in our 50-stock Crabtree Technology portfolio. These include Verizon (VZ), Turkcell (TKC), Atlantic Tele-Network (ATNI) and a few more. The fact that we own six phone companies is almost happenstance – we didn’t go looking for them. Instead, with their huge cash flow and generally steady market share, they found us.

And what about market share? With four major wireless providers in the U.S., and typically only one wireless carriers in any given international region, is market share really changing hands?

Not literally. But in a subtle yet very real way, wireless providers are taking market share. This was made brilliantly apparent by blogger Steve Cichon. In a post this past January, Mr. Cichon pointed out that almost everything found in a 1991 newspaper ad from Radio Shack had been absorbed into a modern smartphone and contemporary wireless service.

Answering machine. CB radio. Alarm clock. Video camcorder. Calculator. CD player. Personal computer. And, of course the land-line and “Mobile Cellular” phones themselves.

Amazing. The wireless industry isn’t swapping much market share among its players, but overall, they’re taking “dollar” share from other industries.

I’m often asked what the big deal about technology is. Why are people so eternally interested in it? So much so that tech remains the single biggest sector (18.6%) of the S&P 500.

I usually answer by saying that tech is interesting because of cool new products, or the way it profoundly changes our world in positive (GPS navigation) and sometimes not-so-positive (texting-while-driving) ways.

But it’s also honest to say that the “thing” about technology is our devices change, but our needs don’t. We need to communicate, so it used to be smoke signals, the telegraph and CB radios. Now it’s mobile phones. Tomorrow it might be telepathy. But underneath, it’s communication. Even cigarettes are not immune to this dynamic, as some smokers leave behind tobacco for electronic cigarettes because nicotine is, well, addictive. Smokers need it, distasteful though that may be to some.

So as investments, wireless service providers seem like a sweet deal: pricing power leading to plenty of cash flow and taking share from seemingly unrelated businesses. Oh, and customers displaying clear signs of addiction. And now, apparently, a growing number are using more than one smartphone: one each for work and play. Life is great for wireless service providers. What could possibly go wrong?

Lots of things. Starting with the self-inflicted wounds common to monopolists and oligopolists, like hubris and myopia. Then there are the here-and-now threats, such as over-the-top texting services like WhatsApp, which rely simply on the broadband connection and not a dedicated texting service plan. These would seem like a major threat to the wireless carriers.

But at the end of the day, the carriers ultimately have the network, without which none of these cool services can happen. In other words, the carriers have assets for which others will need to pay. WhatsApp has $19 billion of Mark Zuckerberg’s money, but they don’t have a network. And telepathy isn’t an option. Yet.

The jury is still out on whether cell phones cause cancer, something long accepted as a certainty for smoking. But as addictions, smoking and smartphones usage appear to be headed in opposite directions: the former marginalized; the latter taking up more and more of our time and money.

So thank you for talking. And texting. And binge-watching “Orange is the New Black” on your smartphone.

Meanwhile, got a light? There’s an app for that, by the way. And the Radio Shack ad didn’t even mention flashlights!

Photo credit: Maxime via Flickr Creative Commons.

DISCLAIMER: The investments discussed are held in client accounts as of March 31, 2013. 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. Past performance is no guarantee of future results.

Tax refunds on record pace: What will you do with yours?

Tax return check

It’s never fun paying taxes, but the good news is that many Americans will be receiving a bigger refund from Uncle Sam this year.

Of course, it’s tempting to go out and spend what seems like “found” money on a vacation or luxury item. Yet saving or investing that refund might be the wiser option.

About three out of four filers typically get refunds, and last year taxpayers received an average refund of $2,755, according to the IRS.

“Individual tax refunds are up 9% over last year and look set to break all-time records. As of the end of week 13 in 2014, Americans have received an incremental $17.6 billion back from the U.S. government over last year,” according to a note from ConvergEx Group.

tax-refunds.png

Some other data points from ConvergEx:

  • Where that money goes is hard to track – we assume taxpayers use half for debt pay down and savings. The other half likely gets spent.

  • In fiscal 2013, the IRS collected over $2,8 trillion dollars from American consumers and businesses.

  • In Fiscal 2013, the IRS processed 146 million individual tax returns and issued 118.5 million refunds.This year, the IRS is quoting refunds levels closer to $3,000, although that includes all types of returns. For many American households, a $3,000 direct deposit is the equivalent of two week’s pay or more.

  • Refunds got off to a slow start in 2014 (for the 2013 tax year), but as of last Friday they were 9.2% higher than the same 13 week period in 2013.That equates to $17.6 billion of incremental payments to taxpayers.

  • The total amount paid out in refunds breached the $200 billion mark in Week 12, and this year’s refunds look to set all-time records in terms of total payments. We’ve included a chart with the annual run rates by week from 2005 to 2014 after this note, along with some other exhibits.

  • When compared to the average amount of IRS refunds since 2005, the scale of 2014’s incremental payments is more pronounced.The average of 2005 – 2013 refund payments is $180 billion, or $20 billion less than the money already distributed this year.

The positive takeaway is that many Americans will be receiving fatter tax refund checks in the mail this year.

It might be a good idea to put that money to work rather than spending it. How? Consider using your refund to pay down debt, boost savings, augment your emergency fund or invest for retirement.

Charles Sizemore, who manages the Dividend Growth portfolio on Covestor, recently discussed the benefits of putting refunds in a traditional or Roth IRA.

“With wage growth being stagnant over the past decade, saving money can be something of a challenge,” he said in a MainStreet report. “However, $3000 placed into a traditional IRA is worth an immediate $750 in tax savings in the 25% tax bracket.”

Photo credit: DRivers@WorldLaw via Flickr Creative Commons.

DISCLAIMER: The information contained in this article is general in nature and not intended as specific advice. Neither Covestor Limited nor its representatives are engaged in rendering tax, accounting or legal advice. A qualified professional should be consulted regarding the effect of such considerations on the matters covered in this article.  

Portfolio manager Carlos Seras talks taxes and investing

radio

Financial Tales Portfolio co-manager Carlos Seras recently appeared on HealthyLife’s News@7 radio broadcast to to talk about tax season and his favorite insights for investors.

Seras discussed some last-minute tax tips with HealthyLife anchor Jay Cruz. Although investors have limited options “this late in the ballgame,” he suggested contributing to IRAs before the April 15 deadline.

The portfolio manager also discussed his investing philosophy and the origins of his Financial Tales blog.

Seras weighed in on how to use moving averages when investing, and why he’s not a fan of a “buy-and-forget” approach.

The full radio interview is embedded below:

Photo credit: dustinjacobsen via Flickr Creative Commons.

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Neither Covestor Limited nor its representatives are engaged in rendering tax, accounting or legal advice. A qualified professional should be consulted regarding the effect of such considerations on the matters covered in this article. Past performance is no guarantee of future results.

IRAs, 401(k)s and more: The alphabet soup of retirement investing

401k-taxes

April is National Financial Literacy Month in the U.S. and also the deadline month for funding various types of retirement accounts.

Therefore, we thought it was a good time to take a quick tour through the array of retirement savings plans available to investors.

Individual Retirement Accounts

Traditional and Roth IRAs are established by individual taxpayers who contribute a portion of their pay. With a Roth IRA, there is no up-front tax break, but you don’t have to pay tax on withdrawals in retirement. The opposite is the case with traditional plans.

There are other important differences between the two as illustrated by this useful chart prepared by the IRS:

IRAs.png

401(k) Plans

This is a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts. Workers choose salary deferrals up to a set amount ($17,500 annually for traditional plans), which are excluded from the employee’s taxable income. That said, 401(k) plans come in many different flavors.

Some companies match employee contributions. However, since the financial crisis in 2008, employers have become less generous with company matches and have set lower limits for the maximum annual payment they’ll make to a 401(k) account.

Simplified Employee Pension Plan

This is basically a traditional IRA plan that is set up for employees by companies.  A business of any size, even self-employed, can establish a SEP.

Such plans are attractive to many companies, because they don’t have the high administrative costs of a conventional retirement plan. Workers can chip in up to 25% of their pay into these plans.

Profit-Share Plans

As the name implies, companies sometimes share their profits with employees in a separate account for each employee. Such contributions are discretionary and there is no set amount a company must make to qualify. There are contribution limits: The lesser of 25% of compensation or $51,000 (for 2013; $52,000 for 2014.

Defined-Benefit Plans

This is your grandfather’s corporate pension plan and increasingly a rarity these days. With a defined benefit pension plan, an employer uses payroll contributions and matching funds to guarantee a specified monthly benefit on retirement.

The amount is determined by a formula based on age, length of service and an employee’s earnings history rather than the fluctuations of investments backing the plan.

According to the Pension Benefit Guaranty Corporation, there are about 38,000 insured defined benefit plans today compared to a high of about 114,000 in 1985. Companies have moved away from defined plans due to their complexity and cost.

Employee Stock Ownership Plans (ESOPs)

Employee ownership plans come in several varieties. Employees can buy stock directly, be given it as a bonus, can receive stock options, or obtain stock through a profit sharing plan. Some employees become owners through At worker cooperatives, where employees become owners, everyone has an equal vote.

But by far the most common form of employee ownership in the U.S. is the ESOP, or employee stock ownership plan.  About 12,000 companies now have ESOPs or similar trust-based plans, covering over 11 million employees, according to the IRS.

Tomorrow is April 15! Check out our recent posts on last-minute tax tips and ideas for investing your tax refund.

Photo credit: helium heels via Flickr Creative Commons.

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Neither Covestor Limited nor its representatives are engaged in rendering tax, accounting or legal advice. A qualified professional should be consulted regarding the effect of such considerations on the matters covered in this article. Past performance is no guarantee of future results.

Ideas for investing your tax refund

tax-refund

Don’t know what to do with your tax refund? Two portfolio managers on Covestor in a recent MainStreet report suggested that individuals should invest their tax refund rather than spending it.

Below are some excerpts from the article:

With the average refund yielding $3,000, investors who put that amount toward an IRA or Roth IRA will have reached half of the contribution limit, depending on whether they qualify, said Charles Sizemore, a CFA based in Dallas who manages four investment portfolios on Covestor, an online marketplace for investing.

"With wage growth being stagnant over the past decade, saving money can be something of a challenge," he said. "However, $3000 placed into a traditional IRA is worth an immediate $750 in tax savings in the 25% tax bracket."

Consumers should use their tax refund dollars to invest in areas of the market which have “great long term prospects and yet are undervalued such as the emerging markets,” said Daniel Beckerman, a portfolio manager on Covestor and a financial planner in Oakhurst, N.J.

"After being led by high momentum stocks for quite a while such as Netflix, Tesla and Amazon, the stock market is now experiencing a healthy rebalance," he said. "The overpriced stocks are being punished and the fundamentally undervalued areas are showing relative outperformance."

Equities in the emerging markets trade at 11 times earnings, which is a substantial discount relative to the U.S. stock market, Beckerman said. The emerging markets dramatically underperformed compared to the U.S. over the past year. A turning point occurred recently and in March, emerging markets rose by 5%. At the same time, the S&P was down 2% and the Nasdaq was down over 5%, he said.

"Most investors are underexposed to the emerging markets sector anyway, so it is a great time to make sure that they have a reasonable allocation there," Beckerman said.

Read the full article at MainStreet.

Photo credit: eFile989 via Flickr Creative Commons.

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Past performance is no guarantee of future results.

April 15 tax deadline may be hurting U.S. stock market

april-15-taxes

The Nasdaq Composite was down nearly 100 points on Thursday afternoon and a lack of market-moving news has some observers blaming the recent weakness in U.S. stocks on the looming April 15 tax deadline.

“The need for investors to raise cash in 2014 to pay substantial capital gains, or taxable income from the sale of investments held longer than a year, has added to selling pressure ahead of the April 15 deadline to file tax returns,” the MoneyBeat blog reports.

Some investors may be unloading stocks to generate cash since they’re facing higher tax bill due to a more than 30% gain for the S&P 500 last year, and increasing taxes.

The theory is that this selling may be at least partly responsible for recent turbulence in the market.

Blogger Ryan Detrick notes that going back four decades, U.S. stocks tend to see some jitters before the April 15 deadline, although the trend for the second half of the month is higher on average.

WSJ.com’s MarketBeat adds that history shows the pre-deadline weakness in U.S. stocks tends to be more pronounced following a big up year for the S&P 500.

s&p-500

Of course, investors shouldn’t rely too much on history. Just because something happened in the past, it doesn’t mean history will repeat.

“These types of seasonal influences are tertiary at best, but it does suggest a very slight headwind, if anything for stocks in the coming days,” said Jason Goepfert, founder of Sundial Capital Research, in the MarketBeat post.

Paying taxes is painful enough, so investors are hoping the U.S. stock market will get back on track after April 15.

Photo credit: eFile989 via Flickr Creative Commons.

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Past performance is no guarantee of future results.