Category Archives: Investiv Daily


Commodities: Stick To The Fundamentals, Beware Of Speculation

  • Oil prices are increasing the number of rigs, putting pressure on prices.
  • Soros sold his gold, should you?
  • Iron ore is hot, but waiting until winter might provide better purchasing opportunities.


Yesterday we discussed how Treasury Inflation-Protection Securities (or TIPS) are a great protection during times of inflation. Today we are going to take a deeper look into another great inflationary protection, commodities.

The general feeling is that commodities have surged since January, but there is a high level of divergence. This divergence in commodity price movements is due to speculation in some commodities and fundamental reasons in others.

Situation – Oil

Oil is currently trading at $46 per barrel which is 75% higher than it was at its low six months ago.

figure 1 oil prices
Figure 1: Oil prices. Source: Bloomberg.

The 75% price jump in oil is a clear indication of price speculation in oil markets because the demand is stable and well known. Speculators include the whole chain, from producers to retailers and future traders who can trade high quantities on margin. In such an environment, the only option is to make an educated guess about the long-term fundamental oil price and trade around it. As Russia and Saudi Arabia are in talks to stabilize the oil market, we could see the market push through year highs, but higher prices call for more global production. As oil prices stabilized above $40, the number of U.S. rigs increased for seven consecutive weeks and the global rig count also increased in July. More rigs mean more supply and further pressure on oil prices.

Investors should be careful with oil, production is very flexible and much of it is low cost which disables a higher level price stabilization. Therefore, oil is a pure trading play with fundamentals easily influenced by speculation.

Situation – Metals

As we discussed gold yesterday while discussing traditional safe haven assets, today we are going to focus on iron ore, copper, zinc and aluminum.

An additional warning for those long gold, George Soros, the legendary hedge fund manager that opened a $263 million position in Barrick Gold in Q1 has cashed out in Q2. Be careful not to get burned on gold as smart money is slowly leaving the playing field.

Iron Ore

Iron ore has had a wild ride this year, but its supply is much less flexible than oil and divergence from fundamentals can be easier to grasp.

figure 2 iron ore
Figure 2: Iron ore prices. Source: Bloomberg.

As iron ore is more predictable than oil, Morgan Stanley sees seasonal weakness ahead, increased supply due to the VALE S11D project, and suggests that prices might fall back to $40 again. Those dips are excellent opportunities to open a position in iron ore miners as when iron ore prices are low, their share prices also decline. By looking at the lowest cost producers, share price is the main risk factor as in the long run, big, low cost miners are unavoidable for global development. Companies to look at are Rio Tinto (RIO), BHP Billiton (BHP), Vale (VALE) and Glencore (GLNCY), but for lower risk it might be better to wait for winter.

Aluminum & Copper

Aluminum is only up 8% year-to-date, and copper is only up 3%. Both metals are a clear example of how commodities diverge. This divergence is what creates opportunity because lower prices tend to eliminate high cost production, limiting supply and pushing prices up again. The current price stability for aluminum and copper, and price increases for precious metals and iron, suggests that the 5-year commodity bear market has come to an end and things should slowly turn as we begin to run into supply deficits due to lower investments.

Aluminum and copper are closely related to global economic growth. An good aluminum play is Alcoa Inc. (AA), while with copper it’s good to look at the lowest cost producers.

figure 3 copper costs
Figure 3: Copper production costs. Source: Southern Copper Corporation (SCCO).

The production cost for the stock pick detailed in The Copper Goldmine—a report I wrote earlier this year, along with an update, that was sent to subscribers last Friday—was $0.92 per copper pound in Q2 2016, and is expected to be $0.52 for the company’s future copper project putting it among the lowest quintile in terms of production costs. To download this report, click here.


Zinc is the superstar metal of the year. It has increased by more than 50% year-to-date and is expected to increase more due to the inevitable supply gap forming. More about the zinc supply gap here.

In addition to our above mentioned stock pick—which is transitioning from a mostly copper producer to a mostly zinc producer in 2017,—another good option to be exposed to zinc, copper and aluminum is the PowerShares DB Base Metals Fund (DBB) with equal weights for zinc, copper and aluminum.


Commodities seem to have reached a bottom, but global economic turmoil or China slowing down might ignite speculators to short metals on margin and put severe downward pressure on prices. Therefore, any commodity related investment has to be done with the notion in mind that 50% of it can quickly be lost.

On the other hand, the world cannot live without commodities and therefore it’s a good idea to be exposed to such an investment, especially to miners as their prices increase exponentially if commodity prices increase due to their fixed costs. Production costs are always the main factor in assessing how much can be lost when investing in commodities.

A good strategy with commodities at this point in the commodity cycle is to average down if commodities experience further declines and then ride in full the eventual upside. The upside is certain as global demand for commodities is expected to grow as a result of increasing demand from developing countries.

To sum things up, commodities are at or near their bottom. The upside impetuses to be aware of are growing global demand, limited supply and potential inflation, while downside risks come from an eventual slowdown in China or a global recession.


Are Safe Havens Really That Safe?

  • Economic laws can’t be muted forever, and in the end always get their due, therefore it is good to look at other options to de-risk your portfolio.
  • Gold is too volatile to be considered a safe haven.
  • Diversification should be the best option to avoid losing everything in a market downturn.


Economics is pretty straightforward. The first thing they teach you in ECON 101 is that the economy works in credit cycles. In a positive environment with low risks and low base interest rates, people borrow and spend. They buy a new car, go on trips, refurbish the kitchen and so on, which leads to economic expansion.

But there is only so much you can borrow, with two new cars in the garage of your new house you start feeling a bit tight and as all your main spending needs are satisfied, you start deleveraging. This leads to an inevitable recession.

Even if a recession might sound crazy at this moment in time, don’t forget that we have had 11 of them since 1945 with the average expansion cycle lasting 58.4 months and the average contraction 11.1 months. The current expansion is already 84 months old which statistically should have led to a recession, but the FED hasn’t allowed for a normal, healthy economic cycle to evolve and is trying to manage economic cycles. The more the economic expansion period is artificially stretched, the stronger the negative economic impact of a future recession will be. A good example to look to is the 2007-2009 Great Recession, which was the longest since the Great Depression.

The Japanese example perfectly demonstrates how monetary easing has its limits. Monday’s data showed that the Japanese economy expanded at an annualized rate of 0.2% in Q2 2016 despite government stimulus.

figure 1 Japan
Figure 1: Annualized quarterly change in Japan’s GDP. Source: Wall Street Journal.

As long term investors, we have to follow the main rule of investing which is not to lose money. Therefore, it is of essential importance to always be looking at risks, which I know isn’t as sexy as buying stocks, but it is what gives long-lasting and outperforming returns.

Among the many risks for investors, today we are going to focus on how safe traditional investing safe havens really are.

Investing Safe Havens

The definition of an investing safe haven states that the investment is expected to retain or even increase its value in market turmoil. The typical safe havens most investors consider are gold, U.S. treasuries—especially TIPS or Treasury Inflation-Protected Securities,—the Swiss franc, and defensive stocks. We shall discuss each of these below.


Gold is considered the ultimate safe haven asset, but due to its incredible volatility, I have a feeling that it’s retail investors who get burned by it, making gold a used-to-be the safe haven.

In wartimes, gold is the only worthy currency due to rampant money printing, however, we are hopefully not even close to a war, but are printing money like we are in a wartime. Even though gold is the ultimate hedge against runaway inflation, we may want to rethink it as a safe haven due to its volatility.

In the 1973-1975 recession, gold surged from below $100 per ounce to above $200 but quickly retreated to its previous level as soon as things got better. In 1980, due to geopolitical instability, gold surged to above $800 and again returned to the $350 levels in 1982. Gold notched up a bit in the 1987 bear market and in the 1991 recession, but did not move in the 2001 recession. In 2002, gold started its majestic bull run from prices around $300 to the highs reached in 2011 of above $1,800, only to retreat to $1,100 this winter. It has again surged to current prices of $1,350/oz.

figure 2 gold price
Figure 2: Gold prices since 1973. Source: Gold Price.

I wouldn’t consider an asset that fell 35% in the 2008 bear market to be a safe haven. Especially given gold’s volatility in the last 10 years, investors should know that gold at this point looks more like a speculation than safe haven investing.

That does not mean we don’t believe you should have some allocation to gold as a protection against an all out fiat currency collapse, just know it will be volatile.

U.S. Treasuries

U.S. treasuries carry two risks; one is the default of the U.S. government which is highly unlikely, while the other is inflation which is not so unlikely given the continuous monetary easing. Therefore, in order to really look for a safe haven, TIPS (Treasury Inflation-Protected Securities) should be examined.

If inflation hits 2% or more, 30-year treasury yields would give a negative real return. On the other hand, TIPS have a much lower yield, with the current spread at 162 basis points which is amongst the lowest spreads in the last five years but would keep giving you a positive real return in inflationary circumstances. The current difference of 1.62% is a lot, but protection always comes at a cost.

figure 3 tips vs yield
Figure 3: 30 year treasuries vs. 30 year TIPS – yields. Source: FRED.

The difference in yields demonstrated in the figure above is pretty high which suggests thinking about diversification in the safe haven bond portfolio. As the main rule of investing is not to lose money, TIPS should be considered.

The Swiss Franc

The Swiss franc (CHF) is similar to gold, when things get rough people flock to it, but you have to sell quickly when things get better. In August 2011 the CHF surged due to contagion fears related to the European debt crisis, but it quickly returned to previous values.

figure 4 chf
Figure 4: USD per 1 CHF. Source: XE.

The CHF is not a long term safe option as it is very volatile and does not provide long term protection.

Defensive Stocks

Defensive stocks usually perform well at the beginning of a bear market but are dragged downwards in later stages as investment funds get tight on liquidity. Defensive stocks can be found in the utilities sector and consumer staples. In the current environment, if you have two stocks with similar valuations and yields you might want to choose the more defensive one as it will limit your losses should a bear market arrive.


Talking about risk is always thankless, you become the grumpy fellow at the party while everyone else is having fun. But investing shouldn’t be about fun, it should be about creating sustainable long-term positive returns.

In this article we have discussed how some safe havens are not that safe due to their volatility and speculation around them, like gold and the Swiss franc. Being protected always comes at a cost which is relatively high when comparing treasuries and TIPS, but it is necessary as global monetary easing and stimulus continues.

The main conclusion is that you have to assess your risks for the returns you are getting. The S&P 500 is up only 4.9% per year in the last 24 months, so consider if those meagre returns are worth the risk of losing more than 20% if a bear market comes along.

The best protection should be diversification that includes TIPS, gold, defensive and growth stocks, domestic and emerging markets. If you continually rearrange the weights in order to minimize risks, you can for certain outperform the market with less risk.



Emerging Markets Are Hot – Here Is Where You Should Put Your Money

  • Emerging markets are up 10% since our last article on the subject, but the FED’s rate action might quickly erase the gains.
  • Valuations are starting to diverge, but don’t fight the trend.
  • Keep an eye on China as it is relatively undervalued and still boosts economic growth of 6.7%.


In May we discussed how emerging markets have been rediscovered but are still undervalued. Since then, the emerging markets ETF is up 10%.

figure 1 emerging markets
Figure 1: iShares MSCI Emerging Markets ETF (EEM) since May. Source: iShares.

As emerging markets include a lot of countries and segments, in this article we are going to see which segments in emerging markets are the best investments and which hold the highest risks.

What Has Been Going On?

The central reason emerging markets have outperformed is because investors regained confidence in them and plowed more capital into them, unlike in 2015 when the story was the opposite. The fact that developed countries continue with their monetary easing increases risk appetite and forces investors to search for better returns in riskier assets such as emerging markets. This partly explains why emerging markets asset prices have been pushed higher.

Not only do stocks enjoy the benefit of global monetary easing, but so do bonds. As emerging markets have higher yields, desperate investors pursue those yields no matter the risks. But this is a common trap in which many investors have been caught in the past. Think of Argentina. This is a typical textbook situation, when yields are high and increasing, people pull their money out of emerging markets in fear that things might get worse. But when yields are falling, and it is unlikely that things will get better, people plow money into emerging markets. The emerging markets premium in comparison to U.S. junk bonds is minimal, but let’s not forget that by holding emerging market debt you are often exposed to currency risks.

figure 2 bond yields
Figure 2: Difference between yields on emerging markets and U.S. junk bonds. Source: Bloomberg.

Such a low premium suggest that investors should carefully assess the risks before investing in emerging markets at these low yields. But what is pushing emerging markets up is the opposite of what pushed them down in 2015, capital inflows and outflows. Since the beginning of 2016, capital inflows have been increasing.

figure 3 flows
Figure 3: Total non-resident capital inflows to emerging markets. Source: Institute of International Finance.

With increased capital inflows, asset prices are bound to go up, but not all emerging markets are enjoying the same investor confidence. China is a good example. Global funds toward China are negative as investors fear the further depreciation of the yuan and slower economic growth.

Fundamental Perspective

From a valuation perspective, emerging markets are still undervalued despite the recent upside. The iShares MSCI Emerging Markets ETF (EEM) has a PE ratio of 11.56 and a price-to-book value of 1.56 which is still far from the iShares S&P 500 ETF (IVV) PE ratio of 20.7 and price-to-book value of 2.88. Chinese stocks are the cheapest with a PE ratio of just 8.24 and a price-to-book value of 1.41 for the iShares MSCI China ETF (MCHI).

figure 4 emerging markets funds
Figure 3: Emerging markets funds. Source: Wall Street Journal.

As our primary investment thesis back in May was that emerging markets are undervalued, the current price increase and investor unwillingness to invest in China make it the probable future winner. To know more about recent developments in China read our recent article on it here.

As global emerging markets are in an uptrend and far from fair valuations, it might be premature to completely jump exclusively into China and ignore other emerging markets. However, as valuations in other emerging markets continue to increase, creating an even larger divergence from China, it might make sense to “overweight” your portfolio toward China, since in the long term earnings are all that matter.

As a point of reference, the Brazil ETF (EWZ) PE ratio is 13.29 while the Indian ETF (INDA) PE ratio is higher at 21.15. Compared to a PE ratio of 8.24 for China.  More daring investors might want to look at Russia where the situation has stabilized but still has low valuations with a PE ratio of 7.36 and a price-to-book ratio of 0.76 for the iShares Russian ETF (ERUS). We’ll discuss more about Russia in a future Investiv Daily article.

For specific investments, the “detailed holdings and analytics” document on the iShares ETFs’ page is a great resource.


When investing in emerging markets, don’t forget about risk. Drops are sudden and sharp, especially around high valuations and low yields. For example, the iShares China ETF (MCHI) is still 28.5% below its 2015 high.

figure 5 china ETF
Figure 4: China ETF. Source: iShares.

The moral of the story is to always look at valuations and don’t get euphoric about emerging markets. Boom and bust cycles are much more frequent than with developed markets due to lower market capitalizations that are strongly influenced by global capital flows which are fickle. We have witnessed two sharp emerging markets declines in the last 12 months—one in August 2015 and the second in January—both of which are a good reminder to not forget that volatility is on the daily menu and another downturn might be just around the corner.

The Fed poses an additional risk to emerging markets if it decides to increase rates due to the tightening U.S. labor market in order to stay ahead of the curve. Higher interest rates in the U.S. would quickly shift capital flows to the less risky U.S. from the riskier emerging markets.


Emerging market are and will stay difficult to navigate. Their volatility is based on low market capitalizations that can easily be influenced with relatively low capital flows when compared to developed markets. Therefore, a good idea is to watch them carefully and not fight the trend because emerging markets tend to move fast in various directions. In January 2016, it seemed like the end of emerging markets was near and now, just 8 months later, it seems all roses.

For investors not exposed to emerging markets, the best thing to do is to look at specific assets that have consistent cash flows and provide diversification. Diversification can also be found in individual companies that have revenues both in the developed world and emerging markets.

Chinese companies have relatively low PE ratios as investors are still not confident about the Chinese economy. Beware that we are not talking here about a recession, but only about growth worries related to China managing to continue growing at more than 6.7% a year.

Stay tuned to Investiv Daily for market updates and specific investment reports on emerging market stocks.


Small Cap Value Stocks Have The Best Returns, But Can You Stomach The Catch?

  • Historically, small cap value stocks are the best performers.
  • They don’t trade in sync with the market and often are waiting to be discovered.
  • The “waiting to be discovered” period can last for a few years.


Almost a month ago we discussed how, from a risk-reward perspective given current valuations and historic performance, it isn’t a smart idea to invest in small cap growth stocks at the moment. Today we are going to discuss small cap value stocks to see if they will fare better on our long-term risk-reward scale.

Small Cap Value

In order to be categorized as a small cap value stock, a company has to have a market capitalization below $2.5 billion and its stock price has to trade below its book value (where possible, or have the lowest book value).

There are several benefits to having a small market capitalization. One is that a company is then always a takeover target and as we discussed last week, that can bring about instant returns when an acquisition is announced. Other benefits include growth prospects as it is easier to grow when you are smaller. For stock pickers like us, it is always a benefit when a company is a small cap because it is less frequently, or even not, followed by analysts, and thorough due diligence pays off as sooner or later the market recognizes good companies even amongst small caps.

On the value side, when a company is trading below its book value it means that the risks of investing are limited because in the case of a business liquidation or bankruptcy, there are enough assets to cover all stakeholders. However, proper due diligence here is essential as there is a big difference between having lots of fixed assets on your balance sheet and having lots of goodwill. In difficult times, goodwill is impaired as the acquisition that created it was obviously a mistake while fixed assets like real estate are of real value on the balance sheet. Researching beyond the balance sheet can bring further benefits as by understanding the story behind a property, plant and equipment account, one can discover that some buildings are completely depreciated and not even on the balance sheet. Such a situation with no analysts following a company is a real gem, but it takes a lot of research of diligently going through every single small cap in the stocks universe.

Small Cap Value – Historical Performance

For those investors who don’t have the time to research small caps in detail, diversified investing into small cap value stocks has been the best thing to do over the past 40 years. Investing into U.S. small cap value stocks would have outperformed all other investment options.

figure 1 size and value
Figure 1: Investing by size and value – performance since 1979. Source: Author’s calculations.


$100 invested into small cap value stocks at the end of 1979 would have returned $11,027 today, while investing in mid cap value stocks would have returned $9,605 in the same time frame, in the S&P 500, $5,199, and in small cap growth stocks only $3,216.

This outperformance is nothing new. Back in 1992, Fama and French developed their famous three factor model—which earned them the Nobel prize (French, unfortunately passed away and was not formally awarded a Nobel)—where they found that value and size give the highest premiums to stock returns. Twenty-four years later, the story should be the same. The iShares S&P Small-Cap 600 Value ETF (IJS) has had an average return 9.48% since its inception in 2000, thus no matter when the measuring started, this strategy outperforms other strategies.

The current PE ratio of the iShares S&P Small-Cap 600 Value ETF is 19.21 which is the same as the iShares Core S&P 500 ETF (IVV), but the difference lies in the price-to-book value which is 1.64 with small cap value stocks, 2.88 with the S&P 500 and 2.92 with the small cap growth ETF. From a fundamental perspective, this is where the difference lies.

Why Do Small Cap Value Stocks Outperform? 

The are many answers to this question. To find them, you have to dig in the dirt and not many analysts are willing to do that as it is easier to follow the crowd with big names. Big investment funds have to wait for a company to reach a large market capitalization to invest in it, but by then the major profits have already been accounted for. If you are an investment manager and you make a mistake by overpaying for a large cap, there will be no hard feelings as everybody else did so as well, but if you recommend a small cap and the story doesn’t end well, you will probably be fired.

The last reason is that value lowers investing risk. If the business doesn’t end well, there are always assets to sell to cover the losses. Therefore, small cap value stocks trade at a premium which ultimately delivers higher returns.

What’s The Catch?

Investing in small cap value stocks comes with a catch that many investors don’t have the stomach for. The catch is that small cap value stocks tend to have a mind of their own and don’t move in sync with the S&P 500. For example, in 2015 the S&P 500 returned 1.3% while small cap value stocks had a return of -6.84%. The same was true in 2014 when the S&P 500 was up 14% while small cap value stocks were only up 6.5%. In 2007, the S&P 500 was up 5% while small cap value stocks lost 8%. How would you feel if when talking to your neighbor, they are up more than 20% in the last two years while you have a negative return?

The thing is that small cap value stocks have to first be discovered by the masses, and only then, when they become trendy, do they boom by getting a fair market valuation. Therefore, an investor may wait for a long time and underperform—like in 2014 and 2015—but sooner or later things change. Year-to-date, small cap value stocks are trendy again and are up 13.6% compared to the S&P 500’s 6.5%.


Investing in small cap value stocks is not for everybody but it delivers the best returns in the long term. The low liquidity, higher uncertainty and general unwillingness to research small caps means a higher premium which in the end, brings about higher returns. Investors who are ready to invest in small cap values will be rewarded in the long term.

In an environment like we’re in now with lots of monetary stimulus, value might be the way to go as assets increase in value in inflationary times. We don’t see inflation yet, but it is bound to happen sooner or later. Growth stocks with high debt levels will be the first ones to suffer when higher interest rates arrive, and historically are the worst performers. Therefore, look into your portfolio and if you don’t have small cap value stocks, be sure to include some.

On Friday we attempted to send you a report Sven had written but had some issues with the links. It just so happens the company featured in this report happens to be a small cap value stock in the metals and mining space that we believe has yet to be discovered by the market. To access this free report ($49 value) click here, and to access the most recent update on the featured company click here.

Many of you also may not have received yesterday’s Sunday Edition featuring a reprint from Thomas Moore’s Rebel Income newsletter. In yesterday’s issue, Thomas discussed why stock assignments aren’t a bad thing and how to take advantage of them. To access the Sunday Edition, click here.


Sunday Edition: Why Stock Assignments AREN’T a Bad Thing

If an investors is looking for a quick entry into a highly liquid stock he may choose to use a market order rather than a limit order.  

However, if he wants to guarantee the price he pays for his shares he will always place a limit order, which will typically be at or below the current quote, unless he is a breakout trader, then his buy limit order may actually be above the current stock price.

Another stock entry technique—which is arguably better than a limit or a market order, especially when trying to buy at or below the current market quote—is to first sell a put option on the stock you wish to acquire and hope for assignment.

Doing so not only allows you to guarantee the price you pay for your shares, which can be at, below, or above the current quote, but also allows you to generate additional income which can lower your cost basis even further.

The risk is if on option expiration the stock isn’t trading at or below the strike price of the put option you sold, you never end up buying shares. If the stock then moves higher, you miss out.

In April 1993, Warren Buffett sold 50,000 contracts (the equivalent of 5 million shares) of out-of-the-money Coca-Cola put options for $1.5 per share and generated $7.5 million in up front cash.

If Coca-Cola stayed above $35 per share on expiration, he got to keep the $7.5 million in cash but would not be assigned the 5 million shares.  

If Coca-Cola dropped below $35, through assignment he would effectively purchase the stock at $33.50 ($35-$1.5 option premium), which was a great price anyway. It was a win-win situation.

In Buffett’s case, he was genuinely hoping for the stock to drop below the $35 put option strike price so that he would be assigned 5 million shares of Coca-Cola at an effective price -14% below the current market quote at the time ($39 per share when he initiated the trade).

Put option assignment or stock ownership is not always the intent of every income trader who sells naked or cash-secured put options. In most cases they are hoping to collect the income, have the put option expire worthless and move on to the next trade.

In today’s reprint of Thomas’ Rebel Income newsletter (annual subscription $1,164), he discusses why put option assignment isn’t a bad thing and how you can turn it into a very profitable trade when done right.

Week 3: Why Stock Assignments AREN’T a Bad Thing

A couple of the questions I see quite a bit from new subscribers are how are they supposed to know when to close a put selling trade I’ve written about, or how are they supposed to avoid buying the stock if it drops below their option’s strike price before expiration. I’d like to use today’s post to elaborate on these questions in more detail.

First, when I sell a put option to open a trade, I’m really looking for one of two results:

  1. The stock closes at expiration at or above the strike price of the put I’ve sold. In this case, the put option expires worthless. I don’t have to do anything to close the trade; I just keep the money I brought in when I sold the put and the option goes away.
  2. The stock closes at expiration below the strike price of the put I’ve sold, which triggers an automatic stock assignment. That means I’ll buy the stock at the strike price of the put I’ve sold.

If the stock closes below the strike price I’ve sold, I will initially be in a negative position, since the stock is lower than my purchase price.

Since the stock assignment in the second case is automatic, I also don’t have to take any additional action. My broker handles the transactional details, I pay the commission fee for the stock purchase, and the shares are now in my account. This is why I don’t write about closing the put selling trade. The put will either expire or I will be assigned the stock, and I’m okay with either result. When I am assigned a stock, I begin looking for opportunities to sell call options against it to generate more income and lower my cost basis in the stock. I like to sell out-of-the-money call options so that if I am called out, I can factor a capital gain into my profit analysis along with the income I’ve generated with the put sale and the covered calls. The covered call is the mechanism I use to “close” a stock position. My Tuesday highlights emphasize put selling first and foremost, but if I have been assigned a stock from one of my highlights and a new covered call opportunity comes along, you may see me write about it on either Tuesday or Thursday.

There is a common perception I’ve seen that thinks of put selling as a directional strategy, like buying a call – you’ll only sell a put if you think the stock will go up. The problem I have with this mindset is that it encourages you to think that a stock assignment from a put sale is something to be avoided. I get questions from time to time about why I don’t “roll” my put options from month-to-month when I’m “underwater” (a common term people seem to like to use when the stock is below the put option’s strike price, meaning that an assignment is likely) on the trade. The first answer is that I have no intention of avoiding a stock assignment; buying the stock actually gives me two ways to keep the income machine going, since not only can I look for opportunities to sell covered calls, but I’ll also be able to draw dividends on the stock if I own it through a dividend declaration.

The principle of “rolling” a naked option is something that I know a lot of directionally-biased traders believe in, because the one thing they don’t want to do is to be forced to fulfill the obligation selling the option put them under. The problem I have with that approach is that in order to avoid the stock assignment, you have to buy the put option back from the market to close the trade. Since the stock’s price will be below the strike price you sold, you will have to pay higher and eat a loss on the trade. For a trading system that centers on income generation, this process is extremely counterproductive.

I’ve written quite a bit in Rebel Income about my belief that you should never sell a put option on a stock you are not willing to own. I’ve seen a lot of traders who think that if the stock drops below their put’s strike price, they would rather just buy the put back from the market, absorb the capital loss on that trade, and move on to the next one. Hopefully, I’ve already explained the transactional problems that creates, but you should not ignore the fact that closing the trade eliminates the possibility of capital gains in the stock once it starts to increase in value again. That means that a big component of my system—which relies on covered calls—is taken completely out of the picture. Over time, those covered call trades have made up an important part of my overall success.

The difficulty, as many of you have seen, comes when the stock is several dollars below the strike price you were assigned at, and keeps dropping. Selling out-of-the-money call options is going to help you lower your cost basis sure, but the further the stock drops, the less likely you are to get any premium of real value from any strike price that is close to, much less above, that net cost. That means that to write a new covered call, you have to be willing to sell a lower strike price and run the risk of a reversal that could call you out of the trade before you’re really ready to. So what do you do?

My answer is actually pretty subjective: sometimes I’ll go ahead and write a covered call, and sometimes I don’t. While some parts of my decision-making process in this situation are based around analytics, others are based around nothing more than my gut instinct. I’ll give you a couple of examples from my historical trades to illustrate.

On November 18, 2014, I sold a put on SLCA with a strike price of $41 per share. The trade covered a month, and at expiration the stock was at $28.41. I was assigned the stock at $41 on December 19th; my net cost in the position at that point was $39.50 per share. The stock was still dropping almost in parallel with oil prices, and although the stock rallied a couple of dollars from a low around $23 in late December, it reversed again and started back down. On December 29, I sold a covered call for 18 days (expired Friday, January 16, 2015) on my shares, this time with a strike price of $29. I was taking a risk at that point, but with the strength of the downward trend, and few signs of a recovery in oil led me to believe the stock wouldn’t be likely to get above that price. Turns out I was right – the stock found a low at $27.50 before reversing.

The picture really only got worse from there – the stock dropped as low as $14 on multiple occasions and has only recently started to move up a bit, sitting at around $23 as of this writing. I’m still holding the stock because the fundamental profile still looks good and I think the upside in the stock is still there in the long-term. I sold a covered call on the stock at $41 in April 2015 when it was approaching its latest peak, which then expired worthless but helped me bring my cost basis down to a little below $37. I also made use of the extended decline to sell additional puts against the stock as a way to average my cost lower in the event of an additional assignment. Those options expired worthless, but they brought in more income that I can also use to reduce my cost basis; it is now around $35 per share. For now, I’m holding the stock and waiting for a new opportunity to write another covered call when the stock rises again to the mid-$30 level.

In December 2015, I sold two put contracts on SYNA. The first was on December 10th with a strike price of $62.50, and an expiration date only 9 days away. The stock closed on December 19th above $68, so this contract expired worthless. On the 23rd, I sold another put contract that expired on January 9th with a strike price of $67.50. The stock closed on the 9th below $61, so I was assigned the stock with a net cost of $65.65 after the assignment. On the 12th, I sold a covered call to expire on January 22nd with a strike price of $62 – once again accepting the risk of being called out lower than my actual cost. At the time, the stock looked like its downward trend would continue, or at the very least the stock should hold somewhere between $58 and $62. Instead, it rallied higher, with strong momentum that has since pushed it to new highs.

Now comes the really subjective part of this process I referred to earlier. A day before expiration, as I was looking at the stock and its current momentum and I thought about my options. First, the stock was about $1 above my $62 strike price; I could wait to get called out and absorb a loss of $3.55 per share. Second, I could buy the call I sold back from the market. The call was priced at $4.40 on the Ask, while I sold it at $.90 to open the trade, so in terms of immediate loss, there was practically no difference, numerically speaking, to sway my decision one way or another. I would have about the same amount of loss in the near term either way. What did I do?

I bought the call back. Why? In looking at this stock’s activity over the previous few days, it seemed clear that other investors agreed with my fundamental opinion that SYNA’s price at that time was a bargain, so they wanted to get in while they could. The stock was also due to report earnings on the next Thursday after expiration, and it seemed clear to me that the market was betting on positive numbers. I decided to let the stock ride for a bit and see how it played out. In this case, the result was great – the stock went to nearly $80, where I wrote another covered call that I was not called out on, then finally called me out of a third covered call trade at $81. My net gain (premiums + capital gain) in the trade for holding a two-month position was more than 24%.

So, if I were to sum up my approach? First, I’ll never sell a put option on a stock that I’m not willing to own – even if the stock drops far below my option’s strike price. Once I’m assigned a stock from a put sale, I take a case-by-case approach for each position, since no two positions are going to behave in exactly the same way. I’ve had a number of other stocks over the last several months that were assigned to me when the put expired and gave me an opportunity to get out with very nice net profits on an exercise from the next month’s covered call. In those cases, the stock’s drop below my put’s strike price wasn’t nearly as deep. It’s really not possible to apply a single method to every single case, so you have to be willing to adapt. Remember that the focus for each position you establish is on income generation; trades that facilitate that process and might help make the occasional stock assignment more cost-efficient are embraced, while trades that help you avoid the obligation of an option sale are counter-productive and more, not less costly to the system in general.

Over the last two years Thomas has outperformed investing legends such as Warren Buffett, Carl Ichan, and David Tepper, earning nearly 30% per year applying his unique Rebel Income system selling put options.

Quite frankly, his track record is unheard of in the financial publishing business. He’s closed exactly 101 trades, of which 98 have been winners with only 3 small losers.  

He is the first to admit that much of his success—especially when it comes to his winning percentage—has to do with how he manages stock positions which are assigned, because the stock has dropped below the put option strike price. 

To get a first-hand look at how Thomas manages his put selling trades, we’ve arranged for you to follow his picks for the next 30 days for only $9, with no obligation to continue. You’ll also receive two incredible bonus items free. Click here to get started.


Shane Rawlings
Co-founder, Investiv


Incredible Investing Opportunity & Free Report

In lieu of an article from Sven Carlin, today we wanted to send Investiv Daily subscribers a ‘Thank You’ in the form of a free report and a special bonus ($49 value).

The Copper Goldmine was written by Sven earlier this year. The report details one particular small cap mining stock that we felt was a great buy, ready to make big gains. Included in this report is an in-depth overview of the company, an analysis of their fundamentals, a detailed look into the market for the primary metals this company mines (copper and zinc), and an explanation on why this company is uniquely positioned to make incredible new highs.

Additionally, we’ve included a special bonus report that takes a look at where the small cap miner discussed in The Copper Goldmine is now—we’ll give you a clue, it has been just over 6 months since the initial report was published and this stock is doing very well—and why it’s still a great buy today.

We hope you enjoy these valuable reports, and we hope that you, like us, look forward to reading Sven’s analyses on the market in each day’s Investiv Daily.

To download your copy of The Copper Goldmine, click here, and click here to download the bonus update report.


Kristina Keene
Editor, Investiv Daily



Minimize Risk Without Sacrificing Returns? Sven Tells You How

  • By dissecting the S&P 500 per valuation quintiles we see that only parts of the market are overvalued.
  • Historically, buying the lowest PE quintile stocks has increased annual returns by 360 basis points.
  • High PE stocks have large market capitalizations which force you to own more of them through index funds, increasing your risks and lowering your returns.


Beyond the top news stories about central banks increasing stimulus to fight the BREXIT or sluggish economic data with high hopes for the future, there is one recurrent theme that still flies under the radar. The recurring theme is that financial markets are overvalued.

As we all know, bull markets climb a wall of worry. Investors who sold everything in 2011 believing markets were overvalued were happy for a while, but are probably still crying now as, if they had not gotten back in the market, they missed a huge upside. We might be in a similar situation where selling now would mean losing much upside, but there is another option.

Figure 1 S&P 500 last 10 years
Figure 1: S&P 500 chart for the last 10 years. Source:

Today we are going to discuss the alleged market overvaluation and dissect it into overvalued and undervalued segments. This is possible as the market is currently all over the place. We are going to end with an example of potential irrational exuberance, social network stocks, and show how such investments can be avoided even when allowing for a high level of diversification.

Dissecting Market Overvaluation

The PE ratio of the S&P 500 is 25.24 if you calculate it by using S&P 500 earnings. By changing methodology, you can get to other averages, but we believe this one to be the most accurate as it looks at aggregate earnings and not stock PE ratios with a lot of negative inputs that skew the result. The average PE ratio for all S&P 500 stocks with negative ratios included ends up at around 19, so don’t get confused by the difference.

In any case, the expected returns with a PE ratio of 25.24 are below 4% per annum, and as corporate earnings are not growing we cannot expect much more. If you hold a diversified ETF or mutual fund that tracks the market, you can’t expect more than 4% returns in the long run, but you should be able to lower your risks and even increase your long term returns if you choose not to include irrationally overvalued companies in your portfolio.

Of course, complete S&P 500 diversification is then out of the question, but here is why. When buying an index, the most expensive stocks have the largest weights because as they get more and more expensive, their market capitalization increases and the fund manager is forced to buy more, which further increases the price and forces the asset manager to buy even more creating a vicious circle that leads into irrational exuberance.

But by looking at quartile valuations of expected forward PE ratios, we see that the market is overvalued only within the highest PE quintile.

figure 2 quintile expected forward PE
Figure 2: S&P 500 PE ratios by quintile. Source: Smead Capital Management.

As historically stocks with the lowest PE ratios have outperformed all other groups, we can limit the risks of a market downturn by shifting our portfolios towards low PE ratio stocks. Those who did that in the last 40 years achieved above market returns of 360 basis points (market average 11.7%, lowest quintile PE stocks 15.3%).

figure 2 PE ratio returns
Figure 3: Returns by valuation quintile. Source: Smead Capital Management.

To give some research aid, here are the 25 S&P 500 stocks with the lowest PE ratios. Be careful because low PE ratios don’t always mean high earnings. Special events like divestitures or future imminent costs can skew PE ratios.

CompanyTickerPE Ratio
Delta Air Lines Inc.DAL3.87
Noble Corp.NE6.44
Yahoo! Inc.YHOO6.64
Valero Energy Corp.VLO7.03
American International Group Inc.AIG8.91
Assurant Inc.AIZ9.42
Danbury Resources, Inc.DNR9.50
Unumprovident Corp.UNM9.59
Deere & Co.DE9.69
Travelers Companies Inc.TRV9.94
CF Industries HoldingsCF9.94
Lincoln National Corp.LNC10.04
Ford Motor Co.F10.23
Hess Corp.HES10.36
International Business Machines Corp.IBM10.39
Verizon Communications Inc.VZ10.48
Lyondellbasell IndustriesLYB10.52
Masco Corp.MAS10.55
Murphy Oil Corp.MUR10.69
Chevron Corp.CVX10.72
AT&T Inc.T10.88
Capital One Financial Corp.COF10.91
Allstate Corp.ALL10.92
Goldman Sachs GroupGS10.95
Figure 4: S&P 500 lowest PE stocks. Source: The Online Investor.

Digging into such a list can give you companies that have stable businesses and low valuations despite any market whim.

High Valuation Example

Not taking anything away from Facebook (FB) or giving any investment analysis, we are going to use it as an example of how a high PE ratio stock can influence our long term investment.

FB’s current weight in the S&P 500 is 1.53% which means that the average Joe that only invests in the S&P 500 has 1.53% of his portfolio in FB. This might be a good thing as FB has had an extraordinary performance since its IPO, but it also means you are paying $125 a share for something that has a book value of $17.54 and EPS of $2.09.

FB will probably continue on its growth path in the future, but investors must understand such a situation carries more risk and the risk can be explained with the huge fall other social networking stocks have witnessed.

figure 5 FB LNKD
Figure 5: Facebook’s, Twitter’s and LinkedIn’s performances in the last 4 years. Source: Yahoo Finance.

LinkedIn has fallen from a price of above $250 per share at the end of 2015 to a price near $100 earlier this year due to lower growth. It was saved by Microsoft which bought it for $26.2 billion, or $196 per share.

Twitter didn’t find any suitors, so its price is still 55% below IPO.

Any change in FB’s growth trajectory, which is bound to arrive sometime as no corporation can grow forever, can have a LinkedIn effect on Facebook which will mean that half of the 1.53% of one’s portfolio would be wiped out.

Another example of high PE ratios and low returns could be Microsoft which bought LinkedIn despite the company not being profitable. Microsoft’s PE ratio is currently around 28 which puts it into the higher valuation quartiles. Microsoft’s weight in the S&P 500 is 2.41%.


The main message of this article is that you can choose where to be invested and you can minimize long term risk and, from an historical perspective, you do not even have to sacrifice your returns. By buying the stocks that are suitable to your investing goals you can achieve better returns and avoid the market risks you don’t like. Those can be social networking stocks, money-losing car makers, or oil companies. Because in order to have a well-diversified portfolio, you only need about 20 stocks.

figure 6 portfolio risk
Figure 6: Number of stocks needed in order to eliminate market risks. Source: Investopedia.

As index funds are created for long-term investors that want to be well diversified, if you want something other than that, you can lower your risk and achieve better returns by buying stocks that have higher earnings as in the long term, stock returns and earnings are perfectly correlated.


Mergers & Acquisitions – Better To Be Invested On The Target’s Side

  • M&A activity has slowed down in 2016 but may increase as BREXIT, China worries cool off and central banks print money.
  • Price to EBITDA premiums have surpassed 2007 levels.
  • The average premium for targets is 37%, which is a pretty good additional return on your investments.


A beautiful situation in investing is when a company you own is being taken over at a lofty premium. In this article we are going to discuss the current M&A market, what it means for the market in general, and take a look into the sectors that offer the best consolidation opportunities.

M&A Overview

Low interest rates push corporations to make acquisitions, but high valuations also make doing so risky. The valuations paid for acquisitions have hit highs not seen since 2007, with the average price to EBITDA multiples being above 11.

figure 1 price to ebitda
Figure 1: Price to EBITDA in acquisitions. Source: Bloomberg.


With many market uncertainties—like the BREXIT, the FED and interest rates, and the upcoming elections—M&A activity has slowed down, with the aggregate deal value being nearly half of what it was in 2015, and with the number of deals also declining.

figure 2 deal volume
Figure 2: Aggregate U.S. deal values. Source: FACTSET.


2015 was a record year for M&A with a total $3.8 trillion spent on deals, which was higher than the previous record set in 2007. In October 2015, 60% of managers expected to make an acquisition in the next 12 months but the small market crisis this winter, which in fact lowered prices, pushed down the M&A confidence barometer to 50% in April.

figure 3 expectations
Figure 5: Expectations to pursue acquisitions. Source: EY.


High valuations force companies to make big deals. The figure below shows how the five biggest deals of Q2 2016 make up almost 20% of all M&A activity.

figure 3 biggest deals
Figure 4: Five biggest deals of Q2 2016. Source: Bloomberg.


M&A Destroys Shareholder Value

An oft posed question is: why do managers insist on M&A when it is known that it destroys shareholder value? This is especially true at high multiples and as seen above, the higher the multiple the more M&A activity there is.

Well, managers are becoming better at acquiring companies and assessing their value, and there are fewer and fewer acquisitions where the main target is the other company’s brand new corporate jet. The added value has recently been slowly climbing.

figure 5 value added
Figure 5: Added value in M&A measured by increase in stock price after announcement. Source: The Economist.


However, increases in stock prices might mean that the market is in an optimistic mode. A longer term perspective will show us that the returns are terrible for companies that engage in M&A. By looking at returns after 3 years or longer from an acquisition, the returns are clearly negative.

figure 6 three year retunr
Figure 6: Longer term acquirer returns (three years). Source: Schroders.


According to the National Bureau of Economic Research, only small firms can benefit from making acquisitions. Over the past 20 years large firms have destroyed $226 billion of shareholder wealth, while small firms have created $8 billion.

To sum it up in style, it is best to quote NY Stern Professor Ashwath Damodaran’s lecture:

I think valuations in M&A are a waste of money and a waste of time. You know why? The value of a target company is always whatever you decide to pay plus $10. Why do we go through this charade? And think of why. You’re my investment banker right? I come to you for some advice. ‘I’m thinking about buying this company, should I buy this company?’ Now think about the two possible answers you can give. ‘You know what, based on the numbers, the deal doesn’t make sense.’ In this case what do you get? The undying gratitude of my stockholders. But try paying bonuses with that. The other is that you can tell me: ‘the deal makes sense.’ In which case you make $50 million.

This is a no brainer. This is like walking up to a plastic surgeon: ‘Is there something wrong with my face?’ What’s the plastic surgeon going to say? ‘You’re perfect.’ His job rests on finding something wrong with your face. There’s too much bias in the process. And its not the investment bankers’ fault, because if the deal maker is also the deal analyst, you’re begging for this kind of conflict.

I’ve never understood. We’re going to talk about the acquisition process, which I think is the most screwed up process. More value is destroyed by acquisitions than any other single action taken by companies. And I think at its root the process is screwed up. Until we fix the process, the valuations are pointless. I guarantee you there is a valuation of AOL in some investment bankers folder somewhere that justifies what Time Warner [paid]… You take the worst deals in history, there is a valuation back there.

With the high valuations and historical negative returns, there is one clear conclusion, it is better to be acquired than to acquire. Therefore, to create positive returns we have to look at smaller companies as they usually have positive returns, both as a target and as an acquirer.


The sectors where the biggest number of acquisitions are expected are oil and gas with 59% of companies ready to make deals in the next 12 months. This is due to low oil prices and many companies being under heavy liquidity pressure, thus the more liquid companies will hunt for bargains and hope for an uptrend in oil prices. Look for debt stressed companies with low cost producing assets.

The same 59% level is in the consumer product and retail sector where low margins and competitive pressures make M&A look like the only option for growth. Unfortunately at high valuations, this will destroy shareholder value, but if you are on the target side some nice returns can be made. The latest example from the sector is Walmart acquiring for $3 billion.

The power and utilities sector is also busy with 58% of companies expecting to make an acquisition in 2016. This sector is one of the most boring sectors, and the best way for growth is through M&As. Companies that have a business and geographic territory that bodes well for a bigger player might be a great target, especially if interest rates start to increase. Locking up a long-term low interest rate to make a profitable acquisition looks like a good thing to do at this point for power and utilities companies.

Another sector where growth is related to GDP is the diversified industrial products sector where M&A are the only option to achieve above average returns. 55% of these companies expect to make an acquisition in 2016.

Smaller chemical companies might also be targets as German BASF has assembled a task force to help it look at potential targets.


M&A are good to keep in mind when creating a portfolio. If you buy AAPL, you can be sure that no one will take it over. But by buying smaller companies that can be an attractive bait for large corporations, you increase potential returns by an average one time hit of 37% at the announcement of an acquisition.

On the other hand, holding big corporations that take over a lot of targets can be risky because their acquisitions create growth but that growth doesn’t result in increased shareholder value, by increased shareholder value we mean increased earnings per share.

To conclude, from an historical perspective, the latest M&A activity and deal valuations signal an overheating market. As always, we do not know exactly when the market will turn bearish, but a good acquisition premium on some takeover targets in our portfolio might be a good reward for the current market risks.


Making The Case: Why Investing In Healthcare Is A Good Move Now

  • Healthcare spending is expected to grow at 5.8% per annum, or around 4% in recession time.
  • The healthcare index is as equally valued as the S&P 500; global healthcare is cheaper.
  • Government involvement and budget limits are the risks, but the risk reward ratio is one of the best in the market.


Yesterday we talked about how the market and the economy are sending mixed signals and look fragile which results in increased risks for low expected returns. One way to be defensive but still grasp the upside is to invest in healthcare stocks. In this article we are going to elaborate on the rationale for investing in healthcare and discuss diversified investing possibilities and risks.

Investing Rationale

Healthcare isn’t a sexy topic because inevitably, day by day, we are getting older. As we age, demand for healthcare increases. The speed at which the U.S. population is getting older will best be explained by the two charts below.

In the 1960s the baby boom is evident. The largest demographic group were children and the oldest group was 85+.

figure 1 1960
Figure 1: Age distribution in 1960. Source: AEI.

In the following 5 decades, things changed. Not only did life expectancy increase with the oldest group now being 100+, but the once children are sill the largest demographic group, only now they are 50 years older (red rectangle).

figure 2 2015
Figure 2: Age distribution in 2015. Source: AEI.

As the baby boomer generation will be retiring in the next decade, let’s be honest, their eating and lifestyle habits haven’t been the best and we can absolutely expect continuing increases in demand for healthcare.

The percentage of people above 65 has increased from 12.29% to the current 14.8% in just 10 years, and the trend will continue. It is expected that the number of people above age 65 in the U.S. will increase from the current 47 million to 58.6 million by 2022, an increase that is expected to increase demand for healthcare by 25%. This 25% increase in the next 6 years is a certainty, unlike many other economic forecasts. In total, U.S. healthcare spending is projected to grow 5.8% annually up to 2024. The Bureau of Labor Statistics expects that healthcare jobs have the fastest employment growth and will add the most jobs between 2014 and 2024, representing 1 in 4 new jobs.

The population is older in Europe where more than 18% of the population is over age 65, and is older still in Japan where 25.71% of the population is above 65. Therefore, global healthcare diversification may be a good idea.

Let us now look at the investment opportunities.

Investment Opportunities

This aging trend and increasing demand for healthcare can be played in various ways. There are pharmaceutical and biotechnology companies, REITs specialized in healthcare, and companies that provide healthcare equipment or services. As this aging trend isn’t a new one, healthcare stocks are fairly valued, so it is necessary to do thorough research to identify the best investments.

If you’re looking for diversification without the headache, an ETF is a good option. The iShares Global Healthcare ETF (IXJ) has a PE ratio of 22.92 and the iShares U.S. Healthcare  ETF (IYH) has a PE ratio of 25.26. With the S&P 500 PE ratio being at 25.21 and given the expected growth outlined above, both ETFs seem undervalued, with the global one being a little bit cheaper. It might look a little late to join the party now as healthcare stocks have had amazing returns in the last 7 years, but with the positive trends continuing there might be more upside.

figure 3 etf growth
Figure 3: iShares U.S. healthcare ETF performance last 10 years. Source: iShares.

Of course with an ETF, you buy a little bit of every company, never mind if the company is good or bad, and you will incur in some additional expenses. Therefore, by being willing to put more effort into it, you can pick the best companies and likely outperform the healthcare index. Low interest rates have enabled many participants to enter the market but they hold high debt levels, so to limit the downside you should look for companies that have a low PE ratio, low debt levels and good growth prospects. With the healthcare index still being below its 2015 high, there are plenty of opportunities to be found.

For more aggressive investors, a good idea might be to look at the biotechnology stocks which have double the volatility of the above mentioned ETFs because of the higher risks involved in developing new drugs. A good, diversified approach can be found in the iShares Nasdaq Biotechnology ETF (IBB), or you can also find great stocks to research in the iShares portfolio.


As with every other investment, investing in healthcare comes with its specific risks. The main risk for healthcare stocks is additional government involvement. As healthcare should be for the common good, the government will always try to at least lower margins if not regulate prices or similar other market influences. The latest concerns for the healthcare industry are the Affordable Care Act and talks of mandated government drug pricing.

In addition to the above mentioned political issues, budget limits could also prevent the growth rate from hitting the expected 5.8%. A recession would quickly limit spending to only the most necessary segments of healthcare, therefore and again, proper stock picking is essential. During the last recession (2009 – 2013), healthcare spending grew at less than 4% annually which is below average, and well below the expected 6% in better economic times, but it was still growth.

When looking at individual healthcare companies, we look at various specific risks that vary from government contracts to various medicaments being replaced by cheaper solutions.


Healthcare is one of the few trends that is certain to grow in the future due to inevitable demographic trends. However, this doesn’t mean that every investment related to healthcare is the best investment.

As the healthcare growth trend has been present for a while now, it is important to carefully analyze each investment and pick the best risk reward options. If a recession comes along, the healthcare index will probably do better than the S&P 500 as it did in 2009 with a 38% decline compared to 55% for the S&P 500.

If you are uncertain about future economic prospects, you might want to dig deeper into healthcare, it is the sector with the most certainties.


Signs of Fragility in the Economy Point to an Impending Bear Market. What To Do Now To Protect Yourself.

  • The last jobs report was good news but it also indicates higher costs and full employment.
  • An “easy to hire, easy to fire” mentality is in the air.
  • Healthcare, cash or short term trades should be the best options in this situation.


Last week the Nasdaq and S&P 500 reached yet another record high. Aggressive central bank stimulation pushes investors to disregard risks and look for any kind of yield or growth. Not looking at risk is the worst thing an investor can do, but they also shouldn’t fight the trend.

Even from a long term perspective the market is irrationally valued, and no one can know how long it will stay that way. Being in cash might seem logical but a 0.1% return looks much worse than the S&P 500’s 8.9% year-to-date return.

Today, we are going to analyze earnings as 86% of S&P 500 companies have reported them, but first take a look at Friday’s jobs report which sent mixed signals.

The Jobs Report

On Friday, the U.S. Bureau of Labor Statistics reported an increase in total non-farm payroll employment of 255,000 in July. The unemployment rate was unchanged at 4.9 percent which is great news for the economy but not so much for investors because it indicates that we are close to full employment. The unemployment rate has stabilized at 4.9% and wages have started to increase (2.6% over the year). Higher wages mean higher costs which have a negative effect on margins and earnings.

figure 1 unemployment rate
Figure 1: Unemployment rate. Source: Bureau of Labor Statistics.

Apart from the reach of full employment and higher wages, the fact that businesses prefer to hire more than to invest in equipment signals that corporations are not so optimistic about the future. They easily hire but know that they can fire with the same ease, if necessary. If you buy equipment, you are stuck with it in most cases.

figure 2 employment equipment
Figure 2: Lower equipment spending in favor of labor. Source: Bloomberg.

The “easy to hire and fire” effect is even more pronounced by the increase in the number of people forced to work part-time for economic reasons, which rose from 5.84 million to 5.94 million.

All of the above means that job numbers are fragile and can quickly shift in the opposite direction. This, along with slow GDP growth, will probably keep the FED on hold or result in minimally increased rates to hold off inflation.

S&P 500 Earnings

The second quarter of 2016 is the fifth consecutive quarter with a decline in earnings.

figure 3 earnings growth
Figure 3: S&P 500 earnings growth rate. Source: FACTSET.

The S&P 500 reported sales were flat in comparison to Q2 2015 which means that the increased hiring does not create growth but is necessary to merely keep up with the competition.

Analysts have postponed expected earnings growth to Q4 2016, which doesn’t mean much as they had expected earnings growth for this and for the next quarter. So, as always, analysts’ expectations have to be taken with a grain of salt.

From a sector perspective, consumer discretionary was the best performer with earnings growth of 10.7% which is logical seeing that consumer spending is the only growth segment of the U.S. GDP. But as consumer discretionary is not essential, any kind of bad news or tightening credit might quickly turn this trend around.

For investors interested in not taking on much risk if a bear market hits us, the healthcare sector continued its good news. Healthcare earnings grew 4.9% and revenue grew 9%. As we know that the global population is getting older, especially in the developed world we can expect demand for healthcare to stay stable, or fall the least in a recession or bear market. Therefore, finding good healthcare investments is essential for a defensive portfolio that is still open to growth in this bull market but limits the potential downside if things take a turn for the worse.

figure 4 sector
Figure 4: S&P 500 Earnings growth by sector. Source: FACTSET.

All other sectors are exposed to negative volatility because consumers are going to save on all things except for food and healthcare. With oil prices around $40 we cannot expect an earnings pickup in the energy sector.

The most important factor for long term investors is valuation. Lower earnings and higher prices have brought the current S&P 500 PE ratio to 25.25. If the FED is forced to increase rates due to high employment rates, corporate earnings will be further pressured downwards by the high debt levels and tightening credit will lower consumer spending.

figure 5 multpl
Figure 5: S&P 500 PE ratio continues to grow. Source: Multpl.


We are in a situation where the S&P 500 is consistently breaking new highs while there have been 5 consecutive quarters of declining earnings, slow GDP growth, lower productivity and where bank credit, the main factor for GDP growth, is about to tighten due to increased interest rates and full consumer indebtedness.

We cannot know for how long such a surreal situation will last, but as smart investors we have to be prepared for the worst and still try to grasp the benefits of the upside. As Warren Buffett has $66 billion in cash on his balance sheet, we might to also want think about having cash on hand just in case a bear market comes that will enable us to buy the bargains. As earnings yields are at 4%, that would be the opportunity cost for holding cash but we can hold cash for 5 years and still break even if a bear market comes along. It is difficult to mentally accept such a strategy as we are in the 7th year of this bull market, but some returns have to be sacrificed in order to lower risks.

Another option for diversification is to use a part of your portfolio for well-placed short term trades. The S&P grew minimally in the last two years but in the meantime it gave great trading opportunities. With stop losses and by knowing what you are doing, you can limit the time you are invested, thus lower the risk of being caught in a bear market while still creating healthy returns on the liquid part of your portfolio.

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