Why Smart Beta Stocks Can Crush the Market
Read more: Why Smart Beta Stocks Can Crush the Market | Investopedia https://www.investopedia.com/news/why-smart-beta-stocks-can-crush-market/#ixzz5IdQPmC5K
Follow us: Investopedia on Facebook
Traditional index funds attempt merely to match the market's performance, and Rob Arnott, founder of Research Associates, derides this as a "buy high, sell low" approach to investing, Barron's reports. The originator of so-called "smart beta" indexes that look to beat the averages, Arnott notes that, by contrast, traditional index funds are structured and managed in such a way that they pass up clear opportunities to beat the market. This strikes him as indefensible. Meanwhile, per Barron's, $730 billion is invested in smart beta products, including $180 billion in funds that have licensed the indexes created by Research Associates. (For more, see also: Smart Beta ETFs Notch More Records.)
The Wisdom of a Smart Beta Ace
Arnott's lengthy interview with Barron's might be distilled into five main points:
|1. Grab low hanging fruit (stocks with market-beating alpha)|
|2. Avoid stocks just added to major indexes|
|3. Buy stocks dropped from major indexes, but wait 3 to 6 months|
|4. Buy deep value emerging markets|
|5. Today's top 10 stocks are likely to underperform over the next 10 years|
1. Grab Low Hanging Fruit
Traditional stock market indexes, and the index funds that attempt to track them, tend to be weighted by market capitalization. By following this formula robotically, the funds are designed to ignore even obvious opportunities to beat the market. By contrast, his smart beta approach favors the creation of indexes based on fundamental factors such as revenues, dividends, corporate governance and diversity that may point to the presence of market-beating alpha.
2. Avoid Stocks Just Added by Indexes
While the indexes, and index funds, are designed to follow the markets, they actually influence them, and thus create market inefficiencies, Arnott notes. When a stock is added to an index, the index funds tied to it rush in to buy, pushing up the price. Arnott's analysis of the S&P 500 Index (SPX) from 1989 to 2017 indicates that new additions underperformed new deletions by an average of 23 percentage points during the following 12 months.
Moreover, he also observes that new additions tend to trade at high valuation multiples, while new deletions "are almost always trading at bargain-bin prices." This is the basis of his critique of traditional index funds as engineered to buy high and sell low.
3. Buy the Rejects, But Wait
As noted above, stocks recently deleted from the major indexes tend to outperform those recently added. However, Arnott suggests that investors be patient and wait about 3 to 6 months before acquiring the rejects, after the downward impact on prices of mass selling by the index funds has run its course. (For more, see also: Getting Better Acquainted With Smart Beta ETFs.)
4. Buy Deep-Value Emerging Markets
Arnott favors this theme between now and the middle of 2019, citing valuations that are about half that of U.S. stocks, based on CAPE ratio analysis. This is a much bigger valuation gap than average historical discount of 20%, he indicates. Any slight improvement in the outlook for these markets can cause valuations to soar, in his opinion.
By contrast, Arnott notes that the CAPE ratio for U.S. stocks is near historic highs, and that a real, inflation-adjusted, cumulative total return (capital appreciation plus dividends) of only about 2.8% would be in the cards for the next 10 years if the current ratio of 32 holds. If the CAPE reverts to its historic mean of 16, he calculates that a real loss of about 3% would be endured over this period. A reversion halfway, to a CAPE of 24, would imply a real return of about zero.
5. Expect Today's Top 10 Stocks to Underperform
Most of the largest companies in the world by market cap are tech companies such as those in the FAAMG group, but most of these trade at high multiples, and "Some of these compete against each other, so the likelihood of all succeeding is limited," in Arnott' s opinion. He cites historical analysis indicating that 8 of the top 10 stocks at any time are likely to drop out of that select group within the next 10 years. "So if your investment horizon is 10 years, those top stocks have about a 90% chance each of underperforming," he says.
Read more: Why Smart Beta Stocks Can Crush the Market | Investopedia
China will impose additional 25 percent tariffs on 659 U.S. goods worth $50 billion in
response to the U.S. announcement that it will levy tariffs on Chinese imports,
the Chinese commerce ministry said.
Tariffs on $34 billion of U.S. goods including agricultural products such as soybeans will
take effect from July 6, the ministry said. Soybeans are China's biggest import from the
United States by value.
The tariffs will also be applied to autos and aquatic products, the ministry said.
The list of 659 U.S. goods was longer than a preliminary list of 106 goods published by
the commerce ministry in April, although the value of products affected remained unchanged
at $50 billion. (http://images.mofcom.gov.cn/www/201806/20180616015345014.pdf)
Aircraft, included in the earlier Chinese list, were not on the revised list.
The effective date of the tariffs on the remaining $16 billion of U.S. goods will be announced
later, according to the commerce ministry. Among the affected $16 billion in U.S. goods
include crude oil, natural gas, coal and some refined oil products.
U.S. President Donald Trump announced on Friday 25 percent tariffs on $50 billion of
Chinese imports, in a move that looks set to ignite a trade war between the world's two
Trump said the tariffs would be imposed on a list of strategically important imports from
China. He also vowed further measures if Beijing struck back.
"The U.S. has ignored China's resolute opposition and solemn representation, and has
insisted on adopting behaviours that violate WTO rules," China's commerce ministry said.
"This is a violation of the legitimate rights and interests that China is entitled to according to
WTO rules, and is a threat to China's economic interest and security."
(Reporting by Ryan Woo; editing by David Evans)
Read more: China to Impose 25 pct Tariffs on 659 U.S. Goods Worth $50 Bln | Investopedia
How Do Interest Rates Affect the Stock Market ?
The investment community and the financial media tend to obsess over interest rates—the cost someone pays for the use of someone else's money— and with good reason. When the Federal Open Market Committee (FOMC) sets the target for the federal funds rate at which banks borrow from and lend to each other, it has a ripple effect across the entire U.S. economy, not to mention the U.S. stock market. And, while it usually takes at least 12 months for any increase or decrease in interest rates to be felt in a widespread economic way, the market's response to a change (or news of a potential change) is often more immediate.
The Interest Rate That Impacts Stocks
The federal funds rate is used by the Federal Reserve (the Fed) to attempt to control inflation. Basically, by increasing the federal funds rate, the Fed attempts to shrink the supply of money available for purchasing or doing things, by making money more expensive to obtain. Conversely, when it decreases the federal funds rate, the Fed is increasing the money supply and, by making it cheaper to borrow, encouraging spending. Other countries' central banks do the same thing for the same reason.
Why is this number, what one bank pays another, so significant? Because the prime interest rate—the interest rate commercial banks charge their most credit-worthy customers—is largely based on the federal funds rate. It also forms the basis for mortgage loan rates, credit card annual percentage rates (APRs) and a host of other consumer and business loan rates.
What Happens When Interest Rates Rise?
When the Fed increases the federal funds rate, it does not directly affect the stock market itself. The only truly direct effect is it becomes more expensive for banks to borrow money from the Fed. But, as noted above, increases in the federal funds rate have a ripple effect.
Because it costs them more to borrow money, financial institutions often increase the rates they charge their customers to borrow money. Individuals are affected through increases to credit card and mortgage interest rates, especially if these loans carry a variable interest rate. This has the effect of decreasing the amount of money consumers can spend. After all, people still have to pay the bills, and when those bills become more expensive, households are left with less disposable income. This means people will spend less discretionary money, which will affect businesses' revenues and profits.
But businesses are affected in a more direct way as well because they also borrow money from banks to run and expand their operations. When the banks make borrowing more expensive, companies might not borrow as much and will pay higher rates of interest on their loans. Less business spending can slow the growth of a company; it might curtail expansion plans or new ventures, or even induce cutbacks. There might be a decrease in earnings as well, which, for a public company, usually means the stock price takes a hit.
Interest Rates and the Stock Market
So now we see how those ripples can rock the stock market. If a company is seen as cutting back on its growth or is less profitable—either through higher debt expenses or less revenue—the estimated amount of future cash flows will drop. All else being equal, this will lower the price of the company's stock. (For related reading, see: Taking Stock of Discounted Cash Flow.)
If enough companies experience declines in their stock prices, the whole market, or the key indexes (e.g., Dow Jones Industrial Average, S&P 500) many people equate with the market, will go down. With a lowered expectation in the growth and future cash flows of the company, investors will not get as much growth from stock price appreciation, making stock ownership less desirable. Furthermore, investing in equities can be viewed as too risky compared to other investments.
However, some sectors do benefit from interest rate hikes. One sector that tends to benefit most is the financial industry. Banks, brokerages, mortgage companies and insurance companies' earnings often increase as interest rates move higher, because they can charge more for lending.
Interest Rates and the Bond Market
Interest rates also affect bond prices and the return on CDs, T-bonds and T-bills. There is an inverse relationship between bond prices and interest rates, meaning as interest rates rise, bond prices fall, and vice versa. The longer the maturity of the bond, the more it will fluctuate in relation to interest rates. (For related reading, see: How Bond Market Pricing Works.)
When the Fed raises the federal funds rate, newly offered government securities, such Treasury bills and bonds, are often viewed as the safest investments and will usually experience a corresponding increase in interest rates. In other words, the "risk-free" rate of return goes up, making these investments more desirable. As the risk-free rate goes up, the total return required for investing in stocks also increases. Therefore, if the required risk premium decreases while the potential return remains the same or dips lower, investors might feel stocks have become too risky and will put their money elsewhere.
One way governments and businesses raise money is through the sale of bonds. As interest rates move up, the cost of borrowing becomes more expensive. This means demand for lower-yield bonds will drop, causing their price to drop. As interest rates fall, it becomes easier to borrow money, causing many companies to issue new bonds to finance new ventures. This will cause the demand for higher-yielding bonds to increase, forcing bond prices higher. Issuers of callable bonds may choose to refinance by calling their existing bonds so they can lock in a lower interest rate.
For income-oriented investors, reducing the federal funds rate means a decreased opportunity to make money from interest. Newly issued treasuries and annuities won't pay as much. A decrease in interest rates will prompt investors to move money from the bond market to the equity market, which then starts to rise with the influx of new capital.
What Happens When Interest Rates Fall?
When the economy is slowing, the Federal Reserve cuts the federal funds rate to stimulate financial activity. A decrease in interest rates by the Fed has the opposite effect of a rate hike. Investors and economists alike view lower interest rates as catalysts for growth—a benefit to personal and corporate borrowing, which in turn leads to greater profits and a robust economy. Consumers will spend more, with the lower interest rates making them feel they can finally afford to buy that new house or send the kids to a private school. Businesses will enjoy the ability to finance operations, acquisitions and expansions at a cheaper rate, thereby increasing their future earnings potential, which, in turn, leads to higher stock prices.
Particular winners of lower federal funds rates are dividend-paying sectors such as utilities and real estate investment trusts (REITs). Additionally, large companies with stable cash flows and strong balance sheets benefit from cheaper debt financing. (For related reading, see: Do Interest Rate Changes Affect Dividend Payers?)
Impact of Interest Rates on Stocks
Nothing has to actually happen to consumers or companies for the stock market to react to interest-rate changes. Rising or falling interest rates also affect investors' psychology, and the markets are nothing if not psychological. When the Fed announces a hike, both businesses and consumers will cut back on spending, which will cause earnings to fall and stock prices to drop, everyone thinks, and the market tumbles in anticipation. On the other hand, when the Fed announces a cut, the assumption is consumers and businesses will increase spending and investment, causing stock prices to rise.
However, if expectations differ significantly from the Fed's actions, these generalized, conventional reactions may not apply. For example, let's say the word on the street is the Fed is going to cut interest rates by 50 basis points at its next meeting, but the Fed announces a drop of only 25 basis points. The news may actually cause stocks to decline because assumptions of a 50-basis-points cut had already been priced into the market. (For related reading, see: 8 Pshychological Traps Investors Should Avoid.)
The business cycle, and where the economy is in it, can also affect the market's reaction. At the onset of a weakening economy, the modest boost provided by lower rates is not enough to offset the loss of economic activity, and stocks continue to decline. Conversely, towards the end of a boom cycle, when the Fed is moving in to raise rates—a nod to improved corporate profits—certain sectors often continue to do well, such as technology stocks, growth stocks and entertainment/recreational company stocks.
Read more: How Do Interest Rates Affect the Stock Market? | Investopedia
China Slams Surprise U.S. Trade Announcement, Says Ready to Fight
China on Wednesday lashed out at Washington's unexpected statement that it will press ahead with tariffs and restrictions on investments by Chinese companies, saying Beijing was ready to fight back if Washington was looking to ignite a trade war.
The United States said on Tuesday that it still held the threat of imposing tariffs on $50 billion of imports from China and would use it unless Beijing addressed the issue of theft of American intellectual property.
The declaration came after the two sides had agreed earlier this month to look at steps to narrow China's $375 billion trade surplus with America, and days ahead of a visit to Beijing by U.S. Commerce Secretary Wilbur Ross for further negotiations.
William Zarit, chairman of the American Chamber of Commerce in China, said Washington's threat of tariffs appeared to have been "somewhat effective" thus far.
"I don't think it is only a tactic, personally," he told reporters on Wednesday, adding that the group does not view tariffs as the best way to address the trade frictions.
"The thinking became that if the U.S. doesn't have any leverage and there is no pressure on our Chinese friends, then we will not have serious negotiations."
China's Commerce Ministry reacted swiftly overnight with a short statement, saying it was surprised and saw it as contrary to the consensus both sides had reached recently.
The Global Times said the United States was suffering from a "delusion" and warned that the "trade renege could leave Washington dancing with itself".
The widely read tabloid is run by the Communist Party's official People's Daily, although its stance does not necessarily reflect Chinese government policy.
"The Chinese government will have the necessary measures in place to deal with a U.S. withdrawal from any settled agreement. If the U.S. wants to play games, then China would be more than willing to play along and do so until the very end," it said.
ZTE AND QUALCOMM
Fears of a trade war between the world's two biggest economies had also receded after the administration of President Donald Trump said it had reached a deal that would put ZTE Corp back in business after banning China's second-biggest telecoms equipment maker from buying U.S. technology parts.
Still hanging in the balance, however, is San Diego-based Qualcomm Inc's proposal to acquire NXP Semiconductors NV - a $44 billion deal that requires clearance from China's antitrust regulators. The recent easing in tensions had fuelled optimism that an agreement was imminent.
"On hold now," a person familiar with Qualcomm's talks with the Chinese government said on Wednesday, declining to be identified as the negotiations are confidential.
"Trump is crazy. Crazy tactics might work, though," the person added.
State news agency Xinhua said China hoped that the United States would not act impulsively but stood ready to fight to protect its own interests.
"China's attitude, as always, is: we do not want to fight, but we are also not afraid to fight," it said in a commentary.
"China will continue to hold pragmatic consultations with the United States' delegation and hope that the United States will act in accordance with the spirit of the joint statement."
Commerce Secretary Ross is scheduled to visit Beijing from June 2 to June 4 to try and get China to agree to firm numbers for additional U.S. exports to the country.
The deal to reduce China's trade surplus with the U.S. was separate from the U.S. probe into China's alleged theft of intellectual property.
A White House official said on Tuesday that the U.S. government plans to shorten the length of visas issued to some Chinese citizens as part of a strategy to prevent intellectual property theft by U.S. rivals.
Citing a document issued by the Trump administration in December, the official said the U.S. government would consider restrictions on visas for science and technology students from some countries.
The China Daily newspaper said the repeated U.S. claim that Beijing had forced foreign firms to transfer their technologies to Chinese businesses was without evidence and was being used as an excuse to facilitate its trade protectionism.
It said technology transfers between U.S. companies and their Chinese partners were the result of normal business practices, not coercive policies. (Reporting by Brenda Goh in SHANGHAI and Michael Martina in BEIJING; Additional writing by Ryan Woo; Editing by Kim Coghill)
With real estate a firm part of the capital allocation matrix for both institutional and
retail investors, real estate funds have been seeing increasing growth recently.
Due to the capital-intensive nature of real estate investing, its requirement for active
management, as well as the rise in global real estate opportunities, institutions seeking
efficient asset management are gradually moving to real estate funds of funds.
The same is true for retail investors, who now benefit from access to a much larger
selection of real estate mutual funds than before, allowing for efficient capital
allocation and diversification. Like any other investment sector, real estate has its
pros and cons. It should, however, be considered for most investment portfolios,
with real estate investment trusts (REITs) and real estate mutual funds seen as possibly
the best methods of filling that allocation.
Real Estate for Institutional Investors
Real estate investment has long been dominated by large players: pension funds,
insurance companies, and other large financial institutions. Thanks to the globalization
of real estate investing and the emergence of new offshore opportunities,
both allowing for a greater degree of diversification as well as return potential,
a permanent place for real estate in institutional portfolio allocations is developing
as a trend.
The permanent allocation of real estate capital comes with certain hurdles.
First and foremost, it is capital intensive. Unlike stocks that can be purchased in
small increments, commercial real estate investments require relatively large sums,
and direct investment often results in lumpy portfolios and inordinate risks in either
location or by property type. Real estate also requires active management, which is
labor intensive. Managing a real estate allocation requires significant resources as
compared to traditional investments. As a result of these issues, aiming to increase
management efficiency and capital distribution, institutions tend to gravitate toward
real estate funds and funds of funds. These same advantages can be achieved by
retail investors through REITs, REIT exchange-traded funds (ETFs), and real estate
Here are several ways for retail investors to access the return potential of real estate
and obtain exposure to the asset class.
This strategy relates to investors directly selecting specific properties. The great advantage
of this strategy is control. Direct ownership of property allows for the development
and execution of strategy, as well as direct influence over return. However, direct
investment makes it very difficult to create a well-diversified real estate portfolio.
For most retail investors, the real estate allocation is not large enough to allow the
purchase of enough properties for true diversification; it also increases exposure to
the local property market, as well as property-type risks.
Real Estate Investment Trusts (REITs)
REIT shares represent private and public equity stock in companies that are structured
as trusts that invest in real estate, mortgages or other real estate collateralized
REITs typically own and operate real estate properties. These may include multifamily
residential properties, grocery-anchored shopping centers, local retail properties
and strip centers, malls, commercial office space, and hotels.
Real estate investment trusts are run by a board of directors that makes investment
management decisions on behalf of the trust. REITs pay little or no federal income
tax as long as they distribute 90% of taxable income as dividends to shareholders.
Even though the tax advantage increases after-tax cash flows, the inability for REITs
to retain cash can significantly hamper growth and long-term appreciation.
Apart from the tax advantage, REITs provide many of the same advantages and
disadvantages as equities.
REIT managers provide strategic vision and make the investment-and property-related
decisions, thus addressing management-related issues for investors.
The greatest disadvantages of REITs for retail investors are the difficulty of investing
with limited capital and the significant amount of asset-specific knowledge and analysis
required to select them and forecast their performance.
REIT investments have a much higher correlation to the overall stock market than
do direct real estate investments, which leads some to downplay their diversification
characteristics. Volatility in the REIT market has also been higher than in direct real
estate. This is due to the influence of macroeconomic forces on REIT values and
the fact that REIT stocks are continuously valued, while direct real estate is influenced
more by local property markets, and is valued using the appraisal method,
which tends to smooth investment returns.
Real Estate Mutual Funds
Real estate mutual funds invest primarily in REIT stocks and real estate operating
companies. They provide the ability to gain diversified exposure to real estate using
a relatively small amount of capital. Depending on their strategy and diversification
goals, they provide investors with a much broader asset selection than can be
achieved by buying REIT stocks alone, and also provide the flexibility of easily moving
from one fund to another. Flexibility is also advantageous to the mutual fund investor
because of the comparative ease in acquiring and disposing of assets on a systematic
and regulated exchange, as opposed to direct investing, which is arduous and expensive.
More speculative investors can tactically overweight certain property or regional
exposure in order to maximize return.
Creating exposure to a broad base of mutual funds can also reduce transaction
costs and commissions relative to buying individual REIT stocks.
Another significant advantage for retail investors is the analytical and research information
provided by the funds on acquired assets, as well as management's perspective on
the viability and performance of real estate, both as specific investments and as an
For investors without the desire, knowledge, or capital to buy land or property on
their own real estate funds allow to participate in the income and long-term growth
potential of real estate. Although real estate mutual funds bring liquidity to a traditionally
illiquid asset class, naysayers believe they cannot compare to direct investment in
Many retail investors who have not considered real estate allocations for their
investment portfolios fail to realize that they may already be investing in real estate
by owning a home. Not only do they already have real estate exposure,
most are also taking additional financial risk by having a home mortgage.
For the most part, this exposure has been beneficial, helping many amass the
capital required for retirement.
What Is A Cash Flow Statement (CFS)?
The statement of cash flows or the cash flow statement, as it's commonly referred to, is a financial statement that summarizes the amount of cash and cash equivalents entering and leaving a company.
The cash flow statement (CFS) measures how well a company manages its cash position, meaning how well the company generates cash to pay it's debt obligations and fund it's operating expenses. The cash flow statement complements the balance sheet and income statement and is a mandatory part of a company's financial reports since 1987.
In this article, we'll show you how the CFS is structured, and how you can use it when analyzing a company. (Also check out our tutorial, An Introduction To Fundamental Analysis.)
The Structure of The CFS
The main components of the cash flow statement are:
- Cash from operating activities,
- Cash from investing activities,
- Cash from financing activities,
- A fourth category, disclosure of noncash activities, is sometimes included when prepared under the generally accepted accounting principles, or GAAP.
It's important to note that the CFS is distinct from the income statement and balance sheet because it does not include the amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as net income, which on the income statement and balance sheet, includes cash sales and sales made on credit. (For background reading, see Analyze Cash Flow The Easy Way.)
Read more: What Is A Cash Flow Statement?
The statement of cash flows shows how a company spends its money (cash outflows) and where the money comes from (cash inflows). The cash flow statement includes all cash inflows a company receives from its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter. In this article, we'll explain the cash flow statement and how it can help you analyze a company for investing.
Why The Cash Flow Statement Is Important
There are two forms of accounting: cash and accrual.
Accrual accounting is used by most public companies and is the accounting method where revenue is reported as income when it's earned rather than when the company receives payment. Expenses are reported when incurred even though no cash payments have been made.
For example, if a company records a sale, the revenue is recognized on the income statement, but the company may not receive cash until a later date. From an accounting standpoint, the company would be earning a profit on the income statement and be paying income taxes on it. However, no cash would have been exchanged. Also, the transaction would likely be an outflow of cash initially since it costs money for the company to buy inventory and manufacture the product to be sold. It's common for businesses to extend terms of thirty, sixty, or even ninety days for a customer to pay the invoice. The sale would be an accounts receivable with no impact on cash until collected.
Although forex is the largest financial market in the world, it is relatively unfamiliar terrain for retail traders. Until the popularization of internet trading a few years ago, forex (FX) was primarily the domain of large financial institutions, multinational corporations and hedge funds. But times have changed, and individual investors are hungry for information on this fascinating
market. Whether you are an FX novice or just need a refresher course on the basics of
currency trading, we'll address some of the most frequently asked questions about the
FX market. (See also our Foreign Exchange tutorial.)
1. How Does the Forex Market Differ from other Markets?
Unlike stocks, futures or options, currency trading does not take place on a regulated
It is not controlled by any central governing body, there are no clearing houses to
guarantee the trades and there is no arbitration panel to adjudicate disputes.
trade with each other based on credit agreements. Essentially, business in the largest,
most liquid market in the world depends on nothing more than a metaphorical handshake.
At first glance, this ad-hoc arrangement must seem bewildering to investors who are used
"Getting to Know Stock Exchanges.") However, this arrangement works exceedingly well
in practice. Self regulation provides very effective control over the market because
participants in FX must both compete and cooperate with each other. Furthermore,
(NFA), and by doing so agree to binding arbitration in the event of any dispute.
Therefore, it is critical that any retail customer who contemplates trading currencies do
so only through an NFA member firm.
The FX market is different from other markets in some other key ways that are sure to
the pair at will. There is no uptick rule in FX as there is in stocks. There are also no limits
on the size of your position (as there are in futures); so, in theory, you could sell $100
billion worth of currency if you had the capital. Interestingly enough, if your biggest
Japanese client, who also happens to golf with the governor of the Bank of Japan,
tells you on the golf course that BOJ is planning to raise rates at its next meeting,
you could go right ahead and buy as much yen as you like. No one will ever prosecute you
for insider trading should your bet pay off. There is no such thing as insider trading in FX;
in fact, European economic data, such as German employment figures, are often leaked
days before they are officially released.
Before we leave you with the impression that FX is the Wild West of finance, we should
note that this is the most liquid and fluid market in the world. It trades 24 hours a day,
from 5 p.m. EST Sunday to 4 p.m. EST Friday, and it rarely has any gaps in price.
Its sheer size and scope (from Asia to Europe to North America) makes the currency
market the most accessible in the world. (See also reviews of forex brokers.)
[Note: Since the forex market is a 24-hour market, there tends to be a large amount of data that can be used to gauge future price movements. This makes it the perfect market for traders that use technical tools. If you want to learn more about technical analysis from one of the world's most widely followed technical analysts, check out Investopedia Academy's Technical Analysis course.]
2. Where Is the Commission in Forex Trading?
Investors who trade stocks, futures or options typically use a broker, who acts as an agent
in the transaction. The broker takes the order to an exchange and attempts to execute it
per the customer's instructions. The broker is paid a commission when the customer buys
and sells the tradable instrument for providing this service.
The FX market does not have commissions. Unlike exchange-based markets, FX is a principals-only market. FX firms are dealers, not brokers. This is a critical distinction that all investors must understand. Unlike brokers, dealers assume market risk by serving as a counterparty to the investor's trade. They do not charge commission; instead, they make their money through the bid-ask spread.
In FX, the investor cannot attempt to buy on the bid or sell at the offer like in exchange-based
markets. On the other hand, once the price clears the cost of the spread, there are no
additional fees or commissions. Every single penny gained is pure profit to the investor.
3. What Is a Pip in Forex Trading?
Pip stands for "percentage in point" and is the smallest increment of trade in FX. In the
FX market, prices are quoted to the fourth decimal point. For example, if a bar of soap in
the drugstore was priced at $1.20, in the FX market the same bar of soap would be quoted
at 1.2000. The change in that fourth decimal point is called 1 pip and is typically equal to
1/100th of 1%. Among the major currencies, the only exception to that rule is the Japanese yen. One Japanese yen is now worth approximately US$0.01; so, in the USD/JPY pair, the quotation is only taken out to two decimal points (i.e. to 1/100th of yen, as opposed to 1/1000th with other major currencies).
4. What Are You Really Selling or Buying in the Currency Market?
The short answer is nothing. The retail FX market is purely a speculative market.
No physical exchange of currencies ever takes place. All trades exist simply as computer
entries and are netted out depending on market price. For dollar-denominated accounts,
all profits or losses are calculated in dollars and recorded as such on the trader's account.
The primary reason the FX market exists is to facilitate the exchange of one currency into
another for multinational corporations that need to continually trade currencies
mergers and acquisitions). However, these day-to-day corporate needs comprise only
about 20% of the market volume. There are 80% of trades in the currency market that
are speculative in nature, put on by large financial institutions, multibillion-dollar hedge
funds and even individuals who want to express their opinions on the economic and geopolitical events of the day.
Because currencies always trade in pairs, when a trader makes a trade they are always
(equivalent to 100,000 units) of EUR/USD, they would have exchanged euros for dollars
and would now be "short" euros and "long" dollars. To better understand this dynamic,
if you went into an electronics store and purchased a computer for $1,000, what would
you be doing? You would be exchanging your dollars for a computer. You would basically be "short" $1,000 and "long" one computer. The store would be "long" $1,000, but now "short" one computer in its inventory. The same principle applies to the FX market, except that no physical exchange takes place. While all transactions are simply computer entries, the
consequences are no less real.
5. Which Currencies Are Traded in the Forex Market?
Although some retail dealers trade exotic currencies such as the Thai baht or the Czech
koruna, the majority trade the seven most liquid currency pairs in the world, which are
the four "majors":
- EUR/USD (euro/dollar)
- USD/JPY (dollar/Japanese yen)
- GBP/USD (British pound/dollar)
- USD/CHF (dollar/Swiss franc)
and the three commodity pairs:
- AUD/USD (Australian dollar/dollar)
- USD/CAD (dollar/Canadian dollar)
- NZD/USD (New Zealand dollar/dollar)
These currency pairs, along with their various combinations
(such as EUR/JPY, GBP/JPY and EUR/GBP), account for more than 95% of all speculative
trading in FX. Given the small number of trading instruments – only 18 pairs and
crosses are actively traded – the FX market is far more concentrated than the
6. What Is a Currency Carry Trade?
Carry is the most popular trade in the currency market, practiced by both the largest hedge
funds and the smallest retail speculators. The carry trade rests on the fact that every currency
in the world has an interest rate attached to it. These short-term interest rates are set by
the central banks of these countries: the Federal Reserve in the U.S., the Bank of Japan
in Japan and the Bank of England in the U.K.
The idea behind carry is quite straightforward. The trader goes long the currency with a
high interest rate and finances that purchase with a currency that has a low interest rate.
For example, in 2005, one of the best pairings was the NZD/JPY cross. The New Zealand
economy, spurred by huge commodity demand from China and a hot housing market,
saw its rates rise to 7.25% and stay there, while Japanese rates remained at 0%.
A trader going long the NZD/JPY could have harvested 725 basis points in yield alone. On a 10:1 leverage basis, the carry trade in NZD/JPY could have produced a 72.5% annual return from interest rate differentials, without any contribution from capital appreciation. Now you can understand why the carry trade is so popular!
But before you rush out and buy the next high-yield pair, be advised that when the carry
trade is unwound, the declines can be rapid and severe. This process is known as carry
trade liquidation and occurs when the majority of speculators decide that the carry trade
may not have future potential. With every trader seeking to exit his or her position at once, bids disappear and the profits from interest rate differentials are not nearly enough to offset the capital losses. Anticipation is the key to success: the best time to position in the carry is at the beginning of the rate-tightening cycle, allowing the trader to ride the move as interest rate differentials increase. (To learn more about this type of trade, see "Currency Carry Trades 101.")
Knowing Your Forex Jargon
Every discipline has its own jargon, and the currency market is no different.
Here are some terms to know that will make you sound like a seasoned currency trader:
- Cable, sterling, pound: alternative names for the GBP
- Greenback, buck: nicknames for the U.S. dollar
- Swissie: nickname for the Swiss franc
- Aussie: nickname for the Australian dollar
- Kiwi: nickname for the New Zealand dollar
- Loonie, the little dollar: nicknames for the Canadian dollar
- Figure: FX term connoting a round number like 1.2000
- Yard: a billion units, as in "I sold a couple of yards of sterling."
Read more: Top 7 Questions About Currency Trading Answered
The bull market in stocks has begun its 10th year with largely sideways movement, and
investors are understandably concerned about what the future holds. Michael Hartnett,
the chief investment strategist at Bank of America Merrill Lynch, recognizes that "asset
markets are struggling" and thus he is tilting towards a bearish view,
according to ZeroHedge.com. Accordingly, he recommends seven trades to investors.
Meanwhile, Callum Thomas, founder of chart-driven macro research house
stocks on the way up it stands to reason that it will be a headwind on the way down.
So this will be one to watch and a risk to be mindful of.”
Hartnett sees "catalysts" for both bull and bear cases, as quoted by ZeroHedge,
observing that the reason for the confusion is "Because it's late-cycle, profits are peaking,
the longest ever if it lasts until August 22, while the current economic expansion in the
U.S. will be the longest since the Civil War if it continues into July 2019, he says.
Hartnett believes that a true bear market is unlikely to begin in 2018, but suggests that
investors start to get defensive. In line with Callum Thomas' concerns about the impact
of an end to QE, BofAML advises rotating from QE winners, such as
7 Ways to Play Defense
As summarized by ZeroHedge, the seven ways that investors can protect themselves
against a market downdraft, per BofAML, are:
- Buy only blue chip, AAA-rated assets
- Go long on U.S. Treasury Bills in the face of rising yields
- Go long on Chinese stocks, based on policy easing and rising corporate credibility there
- Go long on the U.S. dollar, which should rise as a result of "stealth easing" by other central banks
- Go short on emerging markets debt denominated in those countries' currencies
- Short the FAANG technology stocks since these are crowded investments marked by undue optimism
- Short high yield bonds as a hedge against central bank "policy impotence
The main triggers for a move to the downside for the S&P 500, sending it below the
EPS growth, a slowdown in Chinese export growth, geopolitical crises, a crisis in the
credit markets, or the "policy impotence" of central banks in trying to suppress the
Other Bearish Strategies
Anticipating the inevitable onset of the next bear market, Investopedia ran a series of
articles in the fall that presented various strategies that investors might employ to protect
on the S&P 500, and seeking greater diversification, both internationally and regionally.
Also, in line with the recent BofAML recommendations outlined above, these suggestions
included shorting various stocks and sectors, as well as rotating into higher-quality
companies. (For more, see also: Stock Investors' Handbook for a Bear Market.)
More recently, we looked at other advice. Among noted billionaire investors, Warren Buffett
warns against buying stocks on margin and obsessing about scary daily financial headlines
, while Ray Dalio joins Buffett in observing that hasty, panicked selling often is a huge
mistake. Mitch Goldberg, president of investment firm ClientFirst Strategy, insists that
improper diversification is the biggest error made by many investors.
The uptick in volatility so far in 2018 has produced yet more recommendations.
(For more, see also: How to Plan for a Bear Market.)
Read more: 7 Ways to Invest in a Bear Market | Investopedia
Introduction to Elliott Wave Theory
Ralph Nelson Elliott developed the Elliott Wave Theory in the late 1920s. Elliott believed that stock markets, generally thought to behave in a somewhat chaotic manner, in fact traded in repetitive cycles. In this article, we'll take a look at the history behind Elliott Wave Theory and how it is applied to trading.
Cycles and Waves
Elliott proposed that market cycles resulted from investors' reactions to outside influences, or predominant psychology of the masses at the time. He found that the upward and downward swings of the mass psychology always showed up in the same repetitive patterns, which were then divided further into patterns he termed "waves." (For more on the history of technical analysis, check out The Pioneers of Technical Analysis.)
Elliott's theory is somewhat based on the Dow theory in that stock prices move in waves. Because of the "fractal" nature of markets, however, Elliott was able to break down and analyze them in much greater detail. Fractals are mathematical structures, which on an ever-smaller scale infinitely repeat themselves. Elliott discovered stock trading patterns were structured in the same way. He then began to look at how these repeating patterns could be used as predictive indicators of future market moves.
[If you want to supplement your knowledge about Elliott Wave Theory with lessons on the history of Dow Theory and other indicators that every active trader must know, check out Investopedia Academy's technical analysis course.]
Market Predictions Based on Wave Patterns
In the financial markets we know that "every action creates an equal and opposite reaction" as a price movement up or down must be followed by a contrary movement. Price action is divided into trends and corrections or sideways movements. Trends show the main direction of prices while corrections move against the trend. Elliott labeled these "impulsive" and "corrective" waves.
The Elliott Wave Theory is interpreted as follows:
- 1. Every action is followed by a reaction.
- 2. Five waves move in the direction of the main trend followed by three corrective waves (a 5-3 move).
- 3. A 5-3 move completes a cycle.
- 4. This 5-3 move then becomes two subdivisions of the next higher 5-3 wave.
- 5. The underlying 5-3 pattern remains constant, though the time span of each may vary.
Let's have a look at the following chart made up of eight waves (five up and three down) labeled 1, 2, 3, 4, 5, A, B and C.
You can see that the three waves in the direction of the trend are impulses, so these waves also have five waves within them. The waves against the trend are corrections and are composed of three waves each.
In the 1970s, this wave principle gained popularity through the work of A.J. Frost and Robert Prechter.
They published a legendary book on the Elliott Wave entitled Elliott Wave Principle: Key to Stock Market Profits. In this book, the authors predicted the bull market of the 1970s, and Prechter predicted the crash of 1987.
The corrective wave formation normally has three distinct price movements - two in the direction of the main correction (A and C) and one against it (B). Waves 2 and 4 in the above picture are corrections. These waves have the following structure:
Note that waves A and C move in the direction of the shorter-term trend and, therefore, are impulsive and composed of five waves, which are shown in the picture above.
An impulse-wave formation, followed by a corrective wave, form an Elliott wave degree consisting of trends and countertrends. Although the patterns pictured above are bullish, the same applies for bear markets where the main trend is down.
Series of Wave Categories
The Elliott Wave Theory assigns a series of categories to the waves from largest to smallest. They are:
- Grand Supercycle
The Bottom Line
Elliott Wave Theory has its devotees and its detractors like many of the other technical analysis theories out there. One of the key weaknesses is that the practitioners can always blame their reading of the charts rather than weaknesses in the theory. Failing that, there is the open-ended interpretation of how long a cycle takes to complete. That said, the traders who commit to Elliott Wave Theory passionately defend it. To dig deeper into Elliott Wave Theory check out Elliott Wave in the 21st Century.
Read more: Elliott Wave Theory https://www.investopedia.com/articles/technical/111401.asp#ixzz5Ej4eGzS7
Follow us: Investopedia on Facebook
Young professionals who are quantitatively inclined, skilled problem solvers and logical
thinkers, and who keep up to date with the markets should consider a career as a
financial analyst. In a broad sense, financial analysts examine financial data to help
companies make investing decisions.
Some financial analysts work internally and help their employers make investments,
while others work for third-party firms hired by outside clients to lend their expertise.
The field of financial analysis is a rather broad category. Some financial analysts look at
the big picture, analyzing overall market trends to locate profitable investments in different
industries and market segments. Others take a micro approach, breaking investment
opportunities down company by company to try to pinpoint the investment potential of
each. These professionals are called equity analysts.
Buy-Side and Sell-Side Analysts
Equity analysts come in two types: buy-side analysts and sell-side analysts. Buy-side
analysts work for fund managers at mutual fund brokers and financial advisory firms.
They research companies in their employers' portfolios, as well as other companies that
may represent profitable investment opportunities. Based on this research, they prepare
reports that offer buy and sell recommendations to management.
Sell-side equity analysts often work for the big investment banks, such as Goldman Sachs.
Their jobs entail researching the financial fundamentals of companies the bank is
considering taking public and determining which ones have the strongest potential to
For aspiring financial analysts, one of the most important decisions is whether to specialize
as an equity analyst or pursue another niche under the broader umbrella of financial analysis.
The following comparison explains some of the subtle differences between a career as a
financial analyst and an equity analyst.
No licensing board or regulatory authority sets hard-and-fast educational minimums for
financial analysts or equity analysts. However, a bachelor's degree has become a
de facto minimum for receiving an offer to work in either field. Beyond this, the individual
firms doing the hiring set the standards.
Because financial analysis is the broader of the two careers, more employment opportunities
abound, from huge Wall Street investment banks to insurance companies and small,
local firms. Educational standards can vary depending on which of these routes an
applicant pursues. At the very least, he or she should have a bachelor's degree, with the
most preferable majors being economics, finance and statistics.
Equity analysts are much more concentrated on Wall Street at the big investment banks.
The big banks are known to look for the best of the best when hiring those right out of
college. Because of this, they focus their recruiting efforts almost exclusively on top-tier
schools, such as the Ivy Leagues, Duke and the University of Chicago. While applying
with a degree from a lesser-rated school is short of a death knell in the field, the plain fact
is, statistically, a Princeton grad has a much stronger shot at landing an equity analyst
position compared to a graduate of a typical large state university. For graduates of
non-top-tier schools who still want to pursue equity analysis, their best bet is getting into,
and graduating from, an elite MBA program.
Financial analysts and equity analysts need strong analytical and quantitative skills,
problem-solving ability and, equally importantly, a love for the markets. Just as a financial
advisor or stockbroker keeps a finger constantly on the pulse of the market, analysts who
study investment data must do the same to draw accurate conclusions from the data.
While both careers require hard work and dedication, equity analysts in particular, due to
the nature of their likely employers, should be prepared for a tough grind and a lot of work
hours. A job at a big investment bank is not a 9-to-5 gig with weekends off. The average
workweek, particularly during the first few years, could very well be upward of 80 or 90
hours. In fact, some banks have bunk rooms so that analysts working into the night can
crash for a few hours before being back at their desks before the following day's opening
An equity analyst almost invariably makes more money than a traditional financial analyst,
but he or she puts in a lot more hours to earn that money. As of 2017, the average annual
base salary for an entry-level financial analyst was $55,300, according to Salary.com.
Bonuses, when given, are usually small and tied to company performance, not individual
Equity analysts, by contrast, earn a median base salary of $80,400. Equity analysts also
have the potential to double their base pay with bonuses, even during the first year. A
common first-year total income goal for an equity analyst is $140,000. Most financial analysts,
though they make above-average incomes, have to work many years before getting to
the income an equity analyst can make his or her first year, and some never get there.
According to the U.S. Bureau of Labor Statistics (BLS), the job outlook for financial analysts
is strong through 2026. Projected job growth in the field is 11% compared to 7% growth
across all occupations. The BLS lumps equity analysts with financial analysts when
making employment projections.
It's worth noting that the job market for equity analysts is, for obvious reasons, tied to the
health of the big banks. This health was tenuous for a period beginning in 2008, but thanks
to restructuring, along with an injection of taxpayer-funded aid, investment banks are doing much better. Assuming no subsequent turbulence, equity analysts should continue to enjoy a strong job market.
Which One to Choose
These careers require similar skills, education and background. One consideration is what
kind of employer you want to work for. Basically, if you prefer a smaller or mid-sized
company, you have a much better shot as a financial analyst given the aforementioned
fact that most equity analyst jobs are at big investment banks.
Another consideration is, of course, money. If your No. 1 goal is a big paycheck, become
an equity analyst at a big bank. Keep in mind you are probably going to be settling in at
the office for an evening of work while your financial analyst friends are at the gym,
happy hour, or playing rec league softball. If work-life balance is at the top of your list,
lean toward financial analysis, and definitely stay away from the big investment banks.
a 10.2% decline from the record high close on January 26 through the close on February 8,
a brief pullback that lasted just 13 calendar days, per Yardeni Research Inc. Or maybe the
correction is still underway, having lasted 88 calendar days and 52 trading sessions through
April 24, making this the longest correction since May 2008, according to MarketWatch.
Perhaps there are even more ways of looking at corrections.
The 2018 Correction: Conventional Measurement
The S&P 500 closed at a value of 2,872.87 on January 26. This was both its all-time highest
close, and its all-time peak reached at any point during any trading day. The conventional
method for measuring corrections, as used by Yardeni, looks strictly at closing prices.
A correction involves a price decline of at least 10%, and is measured from a market peak
to the subsequent market trough. That trough was reached at the close on February 8,
which was 13 calendar days and 9 trading sessions later, at 2,581.00, 10.2% below the
January 26 peak.
If you expand the analysis to include intraday prices, the trough was reached one day
later, February 9. The S&P 500 sunk as low as 2,532.69 on that day, but recovered to
close at 2,619.55. On this basis, the correction bottomed out at an 11.8% decline.
That intraday low on February 9 is also the lowest point that the index has reached so far
this year. As of the close on April 24, the S&P 500 is down by 8.3% from the January 26
The Alternative Measurement
According to WSJ data reported by MarketWatch, the current correction is the longest since
the one ending on May 1, 2008. From a peak of 1,409.13 on January 9, 2008, the S&P 500
bottomed out at 1,256.98 (10.8% lower) in intraday trading on March 17, 2008, and regained
that peak on May 1, 2008. By this set of definitions, that correction lasted 33 trading days.
MarketWatch cites analysis by The Wall Street Journal Market Data Group that considers
a correction to remain underway until the previous market peak has been regained.
Based on the number of trading days that MarketWatch indicates as the length of the
current correction so far, it is apparent that this method starts the count on the day that
the index first traded below 90% of its previous peak. So, the count began on February 8
and will continue until the S&P 500 reaches 2,872.87 once again, 9.0% above the April 24
Longer Corrections Mean Shorter Bull Markets
The alternative method for measuring corrections also has ramifications for dating and
measuring bull markets. The conventional method considers the current bull market to
have begun at the close on March 9, 2009, the trough of the previous bear market. But if
corrections (and also, presumably, bear market declines of 20% or more) are not deemed
to be over until the previous peak is regained, the current bull market did not really begin
until more than four years later, on March 28, 2013. That is when the previous bull market
peak of 1,565.15, set on October 9, 2007, was reached once again.
MarketWatch essentially argues that the 2018 correction is longer and more severe than
typically reported. To be logically consistent, they also should argue that the current bull market
is much shorter (five years rather than nine years) and of a much smaller magnitude
(a 68% gain rather than a 289% gain through April 24) than standard measurements indicate.
Double Dip Below 10%
Without explaining his methodology, John Stoltzfus, chief investment strategist at Oppenheimer,
told CNBC "we've had two separate 10% pullbacks" this year. More accurately, taking
intraday prices into account, the S&P 500 has been more than 10% below its January 26
peak on two separate occasions, February 8–9 and April 2. In any case, Stoltzfus sees
solid fundamentals that will propel the index to close 2018 at 3,000, whereas other pundits
see a host of negative factors that will trigger a plunge of 30%, 40% or even 60%.
(For more, see also: Stocks' 'Remarkable Resilience' Can Boost Market 12%.)
Recent History of Corrections
Per the WSJ data cited by MarketWatch, the average correction since 1950 has lasted
61 trading days, while the last five corrections have averaged 37 sessions. Analysis by
Goldman Sachs Group indicates that the typical correction takes 70 days to reach the
followed by a recovery period that averages 88 days, MarketWatch adds.
Using what we call the alternative method above, Bloomberg has reported that, on average,
the four corrections after 2009 but prior to 2018 lasted 200 days and reduced the value
of the S&P 500 by 14%. The longest took 417 days. Per the standard method used by Yardeni,
the averages were 106 days and a 15% drop, while the longest lasted 157 days.
(For more, see also: 5 Stock Corrections Show More Pain Ahead.)
Read more: This Stock Correction Is Now the Longest in a Decade | Investopedia
While most news covers sports and politics in a largely intuitive language that caters to
a wide audience, stock market news is typically delivered to a more educated, affluent
demographic that is assumed to be well-versed in investing jargon – even more so in
updates reporting the quarterly and annual successes of a publicly traded company.
In order to get a better understanding of what you read, we’ll briefly explore the terms
you commonly encounter in market news – specifically when a company announces its
earnings. This article will illustrate where you will see these words, what they mean, and
what they pose for a company, using excerpts from an earnings news report covering a
fictional company, Hemlock Incorporated.
Hemlock Incorporated announced its fiscal 2017 Q3 results after the markets closed
, reporting non-GAAP earnings per share of 67 cents, an increase of 17% from the
last quarter, coupled with a net income of $250 million, up from $235 million.
Earnings guidance from Hemlock Incorporated fell within range, with EBITDA,
net income from continuing operations, and free cash flow beyond the high-end of their
respective guidance ranges.
Highlights from the third quarter of 2017 include:
- Cash and cash equivalents of $128 million.
- EBITDA increase of 19% from Q2.
- Free cash flow of $35 million, up from Q2’s $32.7 million
- Total debt increased from $95 million to $100 million.
However, despite the 17% EPS gain, Hemlock Incorporated fell well below the
analyst earnings estimate of 71 cents. Coupled with Hemlock’s increasing total debt,
some analysts are left questioning the company’s ability to service its debt moving
4 Common Terms
Net income in its most basic definition refers to a company’s total earnings or profit.
Simply put, net income is the difference calculated when subtracting all expenses
(including tax expenses) from revenue. When a company’s net income increases,
it’s normally a result of either revenue increasing or expenses being slashed. It goes
without saying that an increase in net income is generally perceived as a positive thing
and factors into a stock’s performance.
subtracting operating expenses from revenue and adding back depreciation and
amortization to operating profit (aka EBIT). EBITDA can be used as a proxy for
free cash flow (FCF) because it accounts for the non-cash expenses of depreciation and
On the income statement, EBITDA is a line item above net income that excludes other
non-operating expenses, as well as interest expenses and taxes. Some could argue that
compared to net income, EBITDA paints a rawer image of profitability.
While some proponents of EBITDA argue that it’s a less-complicated look at a company’s
financial health, many critics state that it oversimplifies earnings, which can create
misleading values and measurements of company profitability.
As a new investor, it’s important to know the distinction between like measurements
because the market allows firms to advertise their numbers in ways not otherwise
regulated. For instance, often companies will publicize their numbers using either
outlines rules and conventions for reporting financial information. It is a means to
standardize financial statements and ensure consistency in reporting.
When a company publicizes their earnings and includes non-GAAP figures, it means they
want to provide investors with an arguably more-accurate depiction of the company’s
health, like removing one-time items to smooth out earnings. However, the further away a
company deviates from GAAP standards, the more room is allocated for some
creative accounting and manipulation (like in the case of EBITDA).
When looking at a company publishing non-GAAP numbers, new investors should be
careful of these pro-forma statements, as they may differ greatly from what GAAP deems
Finally, earnings per share (EPS) is one of the most common things highlighted in an
earnings announcement and provides investors insight into a company’s earnings health
and often affects its stock price after an announcement. EPS is calculated by taking net
income, subtracting the preferred dividends
(for the sake of simplicity, let’s assume Hemlock Incorporated doesn't pay dividends on
preferred shares), and taking that difference and dividing it by the average number of
In the case of Hemlock, its current quarterly EPS is calculated by dividing its net income
of $250 million by the company’s 37 million outstanding shares.
When reported, EPS is typically compared to earnings from either the previous quarter or
the same quarter in the previous fiscal year (year over year, or YoY). It is also used in
Cash on Hand, Money in the Bank
Another thing most news reports look at is how companies manage their money – specifically,
how much they have in free cash flow, total debt, and what assets they have available in
cash equivalents, such as short-term government bonds that they can sell to settle debts.
In Hemlock Inc.’s announcement, free cash flow is increasing, meaning that after all
expenses have been laid out in order to maintain the business’ continuing operations,
the amount of cash it has on hand is growing. On Hemlock’s balance sheet,
the company shows cash and cash equivalents of $128 million, which can be converted
into cash if required, especially in the event that their total debt increases
and/or income takes a hit.
When assessing a company’s quarterly success or failure, pay attention to those terms.
How effectively a company handles the cash it possesses and how it pays down its
debts are both indicators of its ability to grow and increase shareholder value.
Plans and Expectations
Even though Hemlock has seen numbers jump in various areas over the past quarter,
the fact that it missed analysts' estimates may not bode well for investor confidence.
Earnings estimates are forecast expectations of earnings or revenue based on
projections, models and research into the company’s operations and most frequently
expectations for future results.
Even if a company sees an increase in profitability, if the actual earnings fall below
expected earnings, the market will see to it that the stock price adjusts to the new information
(read: drop in value.) This is due to the fact that estimates are usually built into the
current price of a stock. Thus, when investors hear how a company “missed expectations”
in spite of higher revenues being reported, the market corrects the price of the stock
Read more: 10 Common Finance Terms Every Newbie Needs To Know | Investopedia
Private equity is capital made available to private companies or investors.
The funds raised might be used to develop new products and technologies,
expand working capital, make acquisitions, or strengthen a company's balance sheet.
Unless you are willing to put up quite a bit of cash, your choices in investing in the
high-stakes world of private equity are very limited. In this article, we'll show you why
and where you can invest in the private equity game.
Why Invest in Private Equity?
Institutional investors and wealthy individuals are often attracted to private equity
investments. This includes large university endowments, pension plans and family offices.
Their money becomes funding for early-stage, high-risk ventures and plays a major role
in the economy.
Often, the money will go into new companies believed to have significant growth possibilities
in industries such as telecommunications, software, hardware, healthcare and
biotechnology. Private equity firms try to add value to the companies they buy and make
them even more profitable. For example, they might bring in a new management team,
add complementary companies and aggressively cut costs, then sell for big profits.
You probably recognize some of the companies below that received private equity funding
over the years:
- A&W Restaurants
- Harrah's Entertainment Inc.
- Cisco Systems
- Network Solutions (the world's largest domain name registrar)
Without private equity money, these firms might not have grown into household names.
Typical Minimum Investment Requirement
Private equity investing is not easily accessible for the average investor.
Most private equity firms typically look for investors who are willing to commit as much
as $25 million. Although some firms have dropped their minimums to $250,000, this is
still out of reach for most people.
Fund of Funds
A fund of funds holds the shares of many private partnerships that invest in private equities.
It provides a way for firms to increase cost effectiveness and reduce their minimum investment
requirement. This can also mean greater diversification, since a fund of funds might invest
in hundreds of companies representing many different phases of venture capital and
industry sectors. In addition, because of its size and diversification, a fund of funds has
the potential to offer less risk than you might experience with an individual private equity
Mutual funds have restrictions in terms of buying private equity directly due to the SEC's
rules regarding illiquid securities holdings. The SEC guidelines for mutual funds allow up
to 15% allocation to illiquid securities. Also, mutual funds typically have their own rules
restricting investment in illiquid equity and debt securities. For this reason, mutual funds
that invest in private equity are typically the fund of funds type.
The disadvantage is there is an additional layer of fees paid to the fund of funds manager.
Minimum investments can be in the $100,000 to $250,000 range, and the manager may
not let you participate unless you have a net worth between $1.5 million to $5 million.
Private Equity ETF
You can purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly
traded companies investing in private equities. Since you are buying individual shares
over the stock exchange, you don't have to worry about minimum investment requirements.
However, like a fund of funds, an ETF will add an extra layer of management expenses
you might not encounter with a direct, private equity investment.
Also, depending on your brokerage, each time you buy or sell shares, you might have to
Special Purpose Acquisition Companies (SPAC)
You can also invest in publicly traded shell companies that make private-equity investments
in undervalued private companies, but they can be risky. The problem is the SPAC might
only invest in one company, which won't provide much diversification. They may also be
under pressure to meet an investment deadline as outlined in their IPO statement.
This could make them take on an investment without doing their due diligence.
The Bottom Line
There are several key risks in any type of private-equity investing. As mentioned earlier,
the fees of private-equity investments that cater to smaller investors can be higher than
you would normally expect with conventional investments, such as mutual funds.
This could reduce returns. Additionally, the more private equity investing opens up to
more people, the harder it could become for private equity firms to locate good investment
Plus, some of the private equity investment vehicles that have lower minimum investment
requirements do not have long histories for you to compare to other investments.
You should also be prepared to commit your money for at least 10 years; otherwise,
you may lose out as companies emerge from the acquisition phase, become profitable
and are eventually sold.
Companies that specialize in certain industries can carry additional risks. For instance,
many firms invest only in high technology companies. Their risks can include:
- Technology risk: Will the technology work?
- Market risk: Will a new market develop for this technology?
- Company risk: Can management develop a successful strategy?
Despite its drawbacks, if you are willing to take a little more risk with 2% to 5% of your
investment portfolio, the potential payoff of investing in private equity could be big.
(For related reading, see: Grasp the Accounting of Private Equity Funds.)
Read more: How To Invest In Private Equity
Tech stock valuations have reached such high levels that the sector may be due for a
sharp pullback of 20%, says Paul Meeks, a veteran of more than 30 years in the tech
correct they don't just go down 2 percent. They go down 20 percent," as he told CNBC,
adding, "It could happen at any time."
Meeks nonetheless remains bullish on the sector despite these stocks' wild swings.
He says he would use a selloff of 10% or more as a buying opportunity to scoop up
shares of Facebook, Inc.
a very long time, and I can say in my heart of hearts that the fundamentals relative to
the other 10 sectors in the S&P 500 are as good as they've ever been," he told CNBC,
adding, "Fundamentally I like it."
The S&P 500 Information Technology Index (S5INFT) has advanced by a robust 491%
from its bear market low on March 3, 2009 through the close on March 12, 2018, versus
a 300% gain for the S&P 500 Index (SPX) over the same time period,
per S&P Dow Jones Indices. Given that the S&P 500 tech stocks are up by 37.5%
over the past year, per the same source, a 20% pullback would leave investors with
one-year gains of about 10%.
Meeks' Shopping List
"Valuations are extended for some of the names, and everybody's favorite names
particularly the FANGs," Meeks told CNBC. As mentioned, he indicated that FANG
member Facebook is on his shopping list if prices decline though he did not say at what
price. He already holds shares of Apple Inc.
(For more, see also: Amazon, Netflix Selling At 'Crazy' Prices Poised For Big Selloff.)
"I think some of the semiconductors have fallen and they haven't gotten back up.
But I think they're some good opportunities," Meeks also said. He mentioned Advanced
Micron Technology Inc.
(MUMUMicron Technology Inc60.58+2.96%) in this vein. Technology fund manager
Paul Wick is among those who see semiconductor stocks as a cheap way to ride some
of the big secular trends in technology, even at current prices.
Meanwhile, a number of companies in the sector may be acquisition targets.
(For more, see also: Chip Stocks At Record Highs Still a Bargain.)
'1990s Bubble Was MUCH, MUCH Bigger'
The tech-heavy Nasdaq Composite Index reached a new all-time high on March 12,
but investors should note key differences with the Dotcom Bubble, according to
Justin Walters, co-founder of research firm Bespoke Investment Group,
Walters reminded readers that its trailing P/E ratio soared to an incredible 80 times
earnings in 2001, while its valuation has remained below 30 during its current rally.
In fact, as of March 9, its trailing P/E ratio was 27.25, versus 25.79 for the S&P 500,
The S&P 500 tech sector had a forward P/E ratio of 18.6 as of March 1, compared to
17.0 for the entire S&P 500, per analysis by Yardeni Research Inc. The recent bottom
for tech valuations was a forward P/E of about 11 in late 2008, at which time the
S&P 500 had bottomed out at a forward multiple of about 10. During the Dotcom bubble,
the S&P 500 tech sector's forward P/E topped out at just below 50, according to
As far as price gains go, Walters also indicated that the Nasdaq 100 advanced
by 1,223% during the Dotcom Bubble, more than double the 584% advance from its
rally isn't a bubble itself, but it does show that the 1990s bubble was MUCH, MUCH
bigger," he wrote, as quoted by Barron's.
Read more: Why a 20% Plunge In Tech Stocks Is a Buying Opportunity | Investopedia
Read more: Investing - Mutual Funds | Investopedia
Stock investors looking for ways to "de-risk" their portfolio at the peak of the market make
a big mistake by simply rushing into bonds, according to Barron's. Instead, they should
pursue a multifaceted approach. "It's more about reducing the risks within an asset class,
rather than changing the asset mix," as David Lafferty, market strategist at Natixis Global
Asset Management, told Barron's.
(For more, see also: Is It Time To Lock In Your Stock Gains?)
Among the de-risking suggestions from investment professionals interviewed by
Barron's: increase your diversification across countries and regions; put your U.S. stock
allocation into higher-quality companies; and choose bonds carefully, since "some of the
biggest risks lie in bonds," Barron's warns.
(For more, see also: Stocks Face "Nasty Shock" From Fed-Created Bubble.)
Even after posting large gains so far in 2017, European and emerging markets stocks
offer cheaper valuations and better earnings growth prospects than most U.S. equities,
Barron's says. The Oakmark International Investor Fund
(OAKIX) and the Baron Emerging Markets Fund (BEXFX) have good records of success
in finding undervalued companies that offer long-term growth, according to Barron's.
The Oakmark fund has delivered a total return of 36.5% during the past year, placing it in the top 1% of funds in its category, per Morningstar Inc. It also has been in the top 2% in the last three, five and ten-year periods. The Baron fund has a total return of 26.9% during the past year, putting in the top 43% of its category, per Morningstar. It was in the top 4% for the last five-year period.
The Vanguard Total International Stock Index Fund (VGSTX) has delivered a total return
of 24.2% over the past year, placing it in the top 33% of its category, per Morningstar.
This fund is designed to track the MSCI All-Country World Index Excluding U.S., and Morningstar considers its peer group to be foreign large blended funds.
Higher Quality U.S. Stocks
The Jensen Quality Growth Fund (JENRX) has been upgrading an already high quality
in order to reduce risk, Barron's says, adding that portfolio co-manager Eric Schoenstein
cites medical device maker Stryker Corp.
Meanwhile, fund manager Thomas Huber of the T. Rowe Price Dividend Growth Fund
(PRDGX) tells Barron's that medical device makers and financial stocks offer relatively
cheap valuations along with good growth prospects.
(For more, see also: Which Stocks May Outperform in the Next Market Crash.)
The Jensen fund's total return of 20.9% over the past year has lagged both the S&P 500
Index (SPX) and 81% of its peers, according to Morningstar. Longer-term, over the past
ten years, it has been in the top 34% of its peer group. The fund from T. Rowe Price,
meanwhile, has delivered a total return of 19.6% over the past year, behind 76% of its
category, but it is in the top 13% for the last ten-year period, per Morningstar.
The Vanguard Dividend Appreciation ETF
yields 1.8%, per Investopedia data.
Beware of Credit Risk
In reaching for yield, bond investors have been loading up on high-yield debt with high
credit risk. The problem with that approach, Barron's says, is that high-yield bonds act
more like stocks, and thus do not reduce the risk associated with a stock portfolio.
Meanwhile, many bond funds have increased their exposure to high-yield debt,
according to research by Morningstar cited by Barron's.
The bond funds listed in the table above, by contrast, have "gone light on credit risk,"
per Barron's. Moreover, the MetWest fund has had one of the lowest correlations with
stocks over the past decade, Barron's adds.
Read more: How To 'De-Risk' Your Stock Portfolio For A Crash | Investopedia
Short selling allows a person to profit from a falling stock, which comes in handy as stock prices are constantly rising and falling. There are brokerage departments and firms whose sole purpose is to research deteriorating companies that are prime short-selling candidates. These firms pore over financial statements looking for weaknesses that the market may not have discounted yet or a company that is simply overvalued. One factor they look at is called short interest, which serves as a market-sentiment indicator. We'll look at short interest and how it can be used as an indicator for the near-term performance of a stock.
[Short interest is just one market-sentiment indicator that day traders use when deciding when to buy or sell a particular security. For example, a breakout in a stock with a high level of short interest can lead to a snowball effect as shorts cover their position. Investopedia's Become a Day Trader Course will teach you how to use short interest and other indicators to make successful trades.]
The Art of Short Selling
Short selling is the opposite of buying stocks. It's the selling of a security that the seller does not own, done in the hope that the price will fall. If you feel a particular security's price, let's say the stock of a struggling company, will fall, then you can borrow the stock from your broker-dealer, sell it and get the proceeds from the sale. If, after a period of time, the stock price declines, you can close out the position by buying the stock on the open market at the lower price and returning the stock to your broker. Since you paid less for the stock you returned to the broker than you received selling the originally borrowed stock, you realize a gain.
The catch is that you lose money if the stock price rises. This is because you have to buy the stock back at the higher price. In addition, your broker-dealer can demand that the position be closed out at any time, regardless of the stock price. However, this demand typically occurs only if the dealer-broker feels the creditworthiness of the borrower is too risky for the firm. (For a complete overview on short selling, see our Short Selling Tutorial.)
Short Interest Shows Sentiment
Short interest is the total number of shares of a particular stock that have been sold short by investors but have not yet been covered or closed out. This can be expressed as a number or as a percentage.
When expressed as a percentage, short interest is the number of shorted shares divided by the number of shares outstanding. For example, a stock with 1.5 million shares sold short and 10 million shares outstanding has a short interest of 15% (1.5 million/10 million = 15%).
Most stock exchanges track the short interest in each stock and issue reports at month's end, although Nasdaq is among those reporting twice monthly. These reports are great for traders because they allow people to gauge overall market sentiment surrounding a particular stock by showing what short sellers are doing.
News Drives Changes in Short Interest
A large increase or decrease in a stock's short interest from the previous month can be a very telling indicator of investor sentiment. Let's say that Microsoft's short interest increased by 10% in one month. This means that there was a 10% increase in the number of people who believe the stock price will decrease. Such a significant shift provides good reason for investors to find out more. We would need to check the current research and any recent news reports to see what is happening with the company and why more investors are selling its stock.
A high short-interest stock should be approached with extreme caution, but not necessarily avoided at all cost. Short sellers (like all investors) aren't perfect and have been known to be wrong. In fact, many contrarian investors use short interest as a tool to determine the direction of the market. The rationale is that if everyone is selling, then the stock is already at its low and can only move up. Thus, contrarians feel a high short-interest ratio is bullish because, eventually, there will be significant upward pressure on the stock's price as short sellers cover their short positions. (Learn more in Can Perpetual Contrarians Profit as Traders?)
Understanding the Short-Interest Ratio
The short-interest ratio is the number of shares sold short (short interest) divided by average daily volume. This is often called the "days-to-cover ratio" because it determines, based on the stock's average trading volume, how many days it will take short sellers to cover their positions if positive news about the company lifts the price.
Let's assume a stock has a short interest of 40 million shares, while the average daily volume of shares traded is 20 million. Doing a quick and easy calculation (40,000,000/20,000,000), we find that it would take two days for all of the short sellers to cover their positions. The higher the ratio, the longer it will take to buy back the borrowed shares - an important factor upon which traders or investors decide whether to take a short position. Typically, if the days to cover stretch past eight or more days, covering a short position could prove difficult.
The NYSE Short Interest Ratio
The New York Stock Exchange short-interest ratio is another great metric that can be used to determine the sentiment of the overall market. The NYSE short-interest ratio is the same as short interest except it is calculated as monthly short interest on the entire exchange divided by the average daily volume of the NYSE for the last month.
For example, suppose there are 5 billion shares sold short in August and the average daily volume on the NYSE for the same period is 1 billion shares per day. This gives us a NYSE short-interest ratio of 5 (5 billion /1 billion). This means that, on average, it will take five days to cover the entire short position on the NYSE. In theory, a higher NYSE short interest ratio indicates more bearish sentiment toward the exchange and the world economy as a whole by extension. (For related reading, see When to Short a Stock.)
Getting Caught in the Short Squeeze
Some bullish investors see high short interest as an opportunity. This outlook is based on the short interest theory. The rationale is, if you are short selling a stock and the stock keeps rising rather than falling, you'll most likely want to get out before you lose your shirt. A short squeeze occurs when short sellers are scrambling to replace their borrowed stock, thereby increasing demand, decreasing supply and forcing prices up. Short squeezes tend to occur more often in smaller-cap stocks, which have a very small float (supply), but large caps are certainly not immune to this situation.
If a stock has a high short interest, short positions may be forced to liquidate and cover their position by purchasing the stock. If a short squeeze occurs and enough short sellers buy back the stock, the price could go even higher. Unfortunately, however, this is a very difficult phenomenon to predict. (Find out how this strategy is used in The Short Squeeze Method.)
The Bottom Line
Although it can be a telling sentiment indicator, an investment decision should not be based entirely on a stock's short interest. That said, investors often overlook this ratio and its usefulness despite its widespread availability. Unlike the fundamentals of a company, the short interest requires little or no calculations. Half a minute of time to look up short interest can help provide valuable insight into investor sentiment toward a particular company or exchange. Whether you agree with the overall sentiment or not, it is a data point worth adding to you overall analysis of a stock.
Read more: Short Interest: What It Tells Us
The current bull market is just days away from becoming nine years old, given that the previous bear market came to an end with the close of trading on March 9, 2009. Many investors wonder how much longer it can go. Famed investor and market watcher Mohammed El-Erian writes on March 4, as printed in the Financial Times: "The particular sequence of the last month—abrupt correction followed by a rapid bounce back and then last week's pull back—raises interesting questions as to whether markets are in the initial phase of a prolonged sell-off or, instead, being placed on a stronger medium-term footing. The answer to that question will be answered by five factors."
Those five factors are: economic growth; monetary policy; the yield curve; volatility and liquidity; and investor complacency. The Investopedia Anxiety Index (IAI) records very high levels of concern about the securities markets among our millions of readers around the world. While the S&P 500 Index (SPX) has risen by 303% since the end of the last bear market, it is down by 5.0% from its high at the close on January 26, and up by just 2.0% year-to-date through the close on March 6. Meanwhile, volatility as measured by the CBOE Volatility Index (VIX) surged in January, adding to worries among investors who had gotten used to steady gains in stock prices.
Resume in Brief
A contributor to Bloomberg and the Financial Times, El-Erian is the chief economic adviser at Allianz SE, the parent company of asset management firm Pimco, where he previously was CEO and co-chief investment officer (CIO). Among other positions, he also headed the Global Development Council under President Barack Obama, was CEO of the Harvard Management Co., which invests that university's endowment, was a managing director at Salomon Smith Barney (later acquired by Citigroup, then sold to Morgan Stanley), and was a deputy director of the IMF, per Bloomberg.
1. Economic Growth
"Supported by pro-growth policies in the U.S. and a natural economic healing process in Europe, the global economy is in the midst of synchronized pick-up in growth," El-Erian writes. He is encouraged by the fact that consumption and business investment have been the major drivers of growth, rather than "financial engineering." Continued strong economic fundamentals are essential for the markets, he says, and he looks for the markets to be less reliant on liquidity from central banks in the form of asset purchases, or on liquidity from companies in the form of share buybacks, dividends, and acquisitions. He also believes that "growth can gain additional momentum if the world avoids a costly stagflationary trade war."
2. Monetary Policy
An upbeat sign for the U.S. economy, per El-Erian, is that economic growth has strengthened despite tightening by the Federal Reserve in the form of interest rate increases, announcements of future increases, and the cessation of asset purchases called quantitative easing. Indications that other leading central banks will follow a similar path also have failed to derail growth overseas, he notes. However, it remains to be seen, he adds, whether growth will persist "if the policy transition becomes more simultaneous [among]...several systemically-important central banks."
3. The Yield Curve
El-Erian sees a "relatively orderly" increase in bond yields that is reducing incentives for excessive risk taking. Moreover, he believes that the flat yield curve is primarily the result of "investment flows and bond issuance patterns," rather than forces that herald a "significant economic slowdown."
4. Volatility and Liquidity
He also finds it encouraging that volatility as measured by the VIX has increased to a more "realistic and sustainable range" than existed before the correction. Meanwhile, the recent implosion of exotic investment products linked to the VIX, as well as the interest shown by regulators in their failure, should remind investors of the importance of liquidity, he adds. (For more, see also: Stock Sell-Off Has Worrisome Similarities to 2008 Crisis.)
5. Investor Complacency
Another positive sign for El-Erian is that the return of volatility seems to have made investors less confident, and less certain that buying the dips will guarantee gains. In particular, the refusal of central banks to "immediately provide markets with comforting signals" during the correction gave a needed jolt to investor complacency, he adds. "Further progress on all five of these issues would put markets on a firmer footing and lower the risk of a much more dramatic and durable market sell-off," he concludes. (For more, see also: Why Stock Investors Can't Count on a Fed Rescue.)
Meanwhile, quantitative strategists at Bank of America Merrill Lynch note that 13 of their 19 "bear market signposts," or 68%, have been tripped, CNBC reports. These include economic, monetary, earnings and technical indicators, CNBC says, noting "Nearly all of them have usually been triggered before past bear markets."
Additionally, while sustained bear market declines of 20% or more are rare outside of a recession, the current bull market offers a more complicated picture, CNBC indicates, since stock valuations and stock prices raced ahead of the real economy, with stocks eventually becoming "over-owned and over-loved" by January of this year. Whether some over-compensation to the downside is long overdue remains a matter for debate.
Read more: 5 Ways to Stabilize a Volatile Stock Market: El-Erian | Investopedia