A Surprising Opportunity for Possible Yield

Even as markets deal with the infantile reaction to Ben Bernanke’s awkward comments about the end of QE, one thing is clear: The economy, however shaky, continues to improve.

And despite record bond fund outflows and high-profile hemorrhaging at famous equity firms, bank loan funds continue to thrive. Investors poured nearly $15 billion into bank loan mutual funds in the first quarter of 2013, according to Morningstar. 

“There are two reasons you’re hearing about them,” says Mark Okada (left), chief investment officer of Highland Capital and portfolio manager for the Highland Floating Rate Opportunities Fund (HFRAX). “The first is ongoing concern about monetary policy and interest rate risk across the portfolio. The second is that in an improving economy, investors need access to that economy, and it’s something the asset class offers.”

As to the former, Okada says it protects against downside risk from interest rates. Short-term rates are “not going up anytime soon,” he argues, meaning attendant coupons won’t rise, either. And when long-term rates begin to rise, the asset class typically outperforms fixed income.

As to the latter, because it’s below-investment-grade debt, it depends on the health of the underlying issuer, the particular industry and, hence, the overall economy. Below investment grade also translates to bigger spreads and more room for investors to maneuver, Okada adds.

“As the economy improves, they’re getting a credit spread that’s built into the asset class. So why is the asset class good?” he rhetorically asks. “How else can you get access to the improving economy? Equities are volatile; high-yield bonds have a spread premium, but it’s low and it’s largely offset by interest rate risk. Bank loan funds take interest rate risk off the table and don’t have the volatility of equities, high-yield bonds and certainly not emerging-market debt.”

Okada notes that surprisingly, “there’s no upside in bank loan funds.” Value comes from a return of principal plus the coupon, so the key is to identify problems before they happen (which is pretty much every manager’s objective and easier said than done).

 “What we’ve learned is that if a credit analyst is covering less than 30 issues, they know those issues and are on top of them,” he says. “It’s counterintuitive, but we add alpha and beat the market because we sell better than anybody else, rather than looking to buy at the right time.”

The key is those 30 issues. Many more and the only thing the investor captures is downside risk.

“At a certain point, diversification is not your friend,” Okada concludes. “You might not believe it, but a concentrated portfolio is actually less risky because it’s about better issues, not more issues."

---

Check out FINRA Whacks Wells Fargo, Merrill Lynch $5M Over Unsuitable Floating-Rate Bank Loan Funds on AdvisorOne.

What to Look For This Earnings Season? - Ahead of Wall ...

Monday, July 8, 2013

Friday's strong jobs report shed a positive light on the labor market and likely increased the odds of Fed 'tapering' in the coming months. The bond market's move towards pricing in such an outcome has thankfully not become a problem for the stock market, at least not yet. We will know more later this week as minutes of the last FOMC meeting get released. But at this stage, the stock market is taking the 100 basis point jump in benchmark yields since early May in the stride.

Thankfully for us, the focus shifts from the Fed this week to the 2013 Q2 earnings season with the earnings reports from Alcoa (AA) later today and Yum Brands (YUM), J.P. Morgan (JPM) and Wells Fargo (WFC) later this week. Expectations remain low enough that companies wouldn't face much difficulty coming ahead of them. About two-thirds of companies beat earnings expectations in a typical quarter any way and there is no reason to think that the Q2 earnings season will be any different. My sense is that earnings growth and earnings surprises in the Q2 reporting cycle would be along the lines of what we saw in Q1.

Current expectations are for +0.4% growth in total earnings in Q2, down from +3.9% in early April, while total S&P 500 earnings increased by +2.8% in Q1. Nine of the 16 Zacks sectors are expected to show negative earnings growth in Q2. The growth picture in is even more underwhelming when Finance is excluded from the data. Outside of Finance, total earnings for the S&P 500 would be down -3.2% in Q2.

But even more significant than growth rates and surprises will be guidance. Guidance is always important, but it will likely be far more important this time around given the elevated expectations for the second half of the year. Total earnings are expected to be up +5.1% in 2013 Q3 and by +11.7% in Q4, giving us a second-half growth pace of +9.2% from the same period the year before, which comes after +2.7% earnings growth in the first half. Importantly, the gr! owth expectations for the second half are not due to easy comparisons – the level of total earnings expected in 2013 Q3 and Q4 represent new all-time high quarterly records.

My sense is that estimates need to come down in a big way. The market hasn't cared much in the recent past about negative revisions as aggregate earnings estimates have been coming down for over a year now. But if we are entering a post-QE world, as I believe we are, then it will likely be difficult to overlook negative earnings estimate revisions going forward. How the market responds to negative guidance over and the resulting negative revisions will tell us a lot about what to expect going forward.

Sheraz Mian
Director of Research

Pfizer to Reorganize Into 3 Business Segments

Pfizer (NYSE: PFE  ) plans to internally separate its commercial operations into three separate business segments, the company announced today. Two of those segments will include what the company calls innovative business lines, and a third will include its value lines.

One of the innovative segments will include products that cover several therapeutic areas, including inflammation and immunology, CV/metabolic, neuroscience and pain, rare diseases, and women's and men's health. Those products will have market exclusivity beyond 2015.

The other innovative segment will include vaccines, oncology, and consumer health care, with each of those areas operating as a separate global business.

The value business segment will include products that have lost market exclusivity, as well as products that are mature, patient-protected, and expected to lose exclusivity through 2015 in most major markets. Those products will be positioned to provide lower-cost treatments to patients.

The value business line will also include biosimilar products and those that come about from current and future collaborations, such as with Mylan in Japan, Teuto in Brazil, and Hisun in China.

The three segments will be operating in developed as well as developing markets. In countries that don't require consultation with employee organizations, such as unions, the changes will take place in January. In other countries, the changes will take place after the necessary consultation.

Meet the Surprising Company That’s Helping the iPad Destroy PCs

Is there any good news left for PC makers? New data supplied to TechCrunch from ad platform Karbon says iPad video traffic is up 150% over the past six months. Researchers NPD and IDC both peg tablets as outselling laptops no later than next year. And now, as if to prepare for the shift, longtime PC peripherals maker Logitech (NASDAQ: LOGI  ) has introduced a wired iPad keyboard.

The news comes at an opportune time for Apple (NASDAQ: AAPL  ) shareholders, who have seen their company's stock suffer in a news vacuum. CEO Tim Cook probably didn't help matters when he refused to even hint at new products at the recent All Things Digital tech conference, says Tim Beyers of Motley Fool Rule Breakers and Motley Fool Supernova.

For Apple investors, Tim says Logitech's move is reflective of a welcome movement toward alternative computing devices and away from PCs. Few companies are better positioned to profit from the shift than the iEmpire, which made its own change six years ago when the late Steve Jobs dumped "Computer" from Apple's corporate moniker.

Do you agree? Please watch the video to get Tim's full take, and then let us know whether you're using an iPad or other tablet as a PC replacement -- and if so, how.

Five stocks enter, one stock leaves
It's incredible to think just how much of our digital and technological lives are almost entirely shaped and molded by just a handful of companies. Find out "Who Will Win the War Between the 5 Biggest Tech Stocks?" in The Motley Fool's latest free report, which details the knock-down, drag-out battle being waged by the five kings of tech. Click here to keep reading.

Consistency supports Bed Bath & Beyond

Stockholders of Bed Bath & Beyond (BBBY) have become accustomed to the company's consistent growth. Over the last 16 quarters, the company has averaged sales gains of 11% and per-share-profit growth of 30%.

At the end of February, Bed Bath & Beyond operated 42 million square feet of selling space, up 16% from a year earlier. Its 1,471 locations included more than 1,000 of its namesake stores in all 50 states, as well as Puerto Rico and Canada.

Growth has slowed in recent quarters — no surprise given the series of stresses U.S. consumers have absorbed — but should pick up in coming months.

Standard & Poor's projects a 34% increase in housing starts this year, building on a 28% increase last year. More housing starts should translate into greater demand for such goods as linens and housewares.

The consensus projects sales growth of 7% and per-share-profit growth of 10% in the year ending February 2014. If the economy keeps improving and Bed Bath & Beyond can approach the high end of its same-store-sales guidance (up 2% to 4% for the current fiscal year), the consensus should prove conservative.

In the last fiscal year, Bed Bath & Beyond generated $1.19 billion in operating cash flow and spent more than $1 billion repurchasing its own shares, including $305 million in the February quarter alone.

The company has reduced its share count 6% over the last year and 15% over the last three. At the end of February, the retailer had $2.4 billion left on its repurchase authorization, enough to reduce the share count 16% at current prices.

Despite its consistent profit growth and a price gain of 25% so far this year, Bed Bath & Beyond trades at 15 times trailing earnings, 7% below its five-year median P/E ratio and 19% below the median specialty retailer. The stock is a Long-Term Buy.

TheStreet Acquires DealFlow Assets

TheStreet's (NASDAQ: TST  ) asset list is slightly longer following the financial media company's latest acquisition. The company announced that it bought several properties from DealFlow Media in order to compliment its offerings. Those assets are The DealFlow Report and The Life Settlements Report, both newsletters, and PrivateRaise, a database.

The terms of the acquisition were not disclosed, although TheStreet said in a press release that the financial impact of the acquisition "is not expected to be material."

All three assets will be folded into The Deal, TheStreet's institutional platform.

More Expert Advice from The Motley Fool

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock in our brand-new free report: "The Motley Fool's Top Stock for 2013." I invite you to take a copy, free for a limited time. Just click here to access the report and find out the name of this under-the-radar company.

4 Stocks Making Moves

The following video is from Wednesday's Investor Beat, in which host Chris Hill and analysts Jason Moser and Lyons George dissect the hardest-hitting investing stories of the day.

In this installment, our analysts discuss four stocks making big moves. CarMax (NYSE: KMX  ) hits an all-time high after fourth-quarter profits rise. PriceSmart (NASDAQ: PSMT  ) jumps after the retailer reports better-than-expected results. Fastenal (NASDAQ: FAST  ) falls after it reports weaker-than-expected revenues. And 3D Systems (NYSE: DDD  ) racks up big gains after one of its competitors gets an upgrade. 

3D Systems is at the leading edge of a disruptive technological revolution, with the broadest portfolio of 3-D printers in the industry. However, despite years of earnings growth, 3D Systems' share price has risen even faster, and today the company sports a dizzying valuation. To help investors decide whether the future of additive manufacturing is bright enough to justify the lofty price tag on the company's shares, The Motley Fool has compiled a premium research report on whether 3D Systems is a buy right now. In our report, we take a close look at 3D Systems' opportunities, risks, and critical factors for growth. You'll also find reasons to buy or sell the stock today. To start reading, simply click here now for instant access.

The relevant video segment can be found between 2:57 and 6:50.

It Ain’t Over Yet: Dow Tumbles 270 Points as IMF Spooks Stocks

Blame the IMF.

EPA

Investors were in selloff mode today after the International Monetary Fund cut its global economic growth forecast today. The S&P 500 fell 1.5% to 1,935.08 today, while the Dow Jones Industrial Average dropped 272.58 points, or 1.6%, to 16,719.33. The Nasdaq Composite declined 1.6% to 4,385.20 and the small-company Russell 2000 tumbled 1.7% at 1,076.31.

For a market already suffering from growth fears, the IMF did nobody any favors. It reduced its 2015 global-growth forecast to 3.8% today from 4% in July, and warned of the possibility that the euro area could fall into recession…again. It left its 2015 US growth forecast unchanged at 3.1%.

Gluskin Sheff’s David Rosenberg explains why the stock slump might not be over yet:

There have actually been no fewer than 13 mini-corrections since the bull market began in March 2009. On Average, the S&P 500 declines 8.7% over a 34 day span (the median is -7.2% over 28 days). The forward P/E multiple corrects down by 1.3 point and the trailing by 2.0 point – both the mean and the median are basically in agreement on this. High-Yield bonds spreads widen out an average of 83 basis points (median is 62 basis points). The 1o-year US treasury note yield in these risk-off phases fall 40 basis points (both average and median). Relative strength in the Small-Cap stocks is -300 points on average and -200 basis points on a median basis and equity market sentiment as per Market Vane bullishness has retreated nine percentage points by the time the capitulation low in the S&P 500 is turned in – this is the case whether you look at the history either on an average or median basis.

So far, the S&P 500, even with all the ups and downs since the mid-September peak, has corrected but 2%, even though it may feel worse than that given the volatility. The VIX has only jumped 20%, p less than half what one would like to see at an interim market trough. Both the trailing and forward P/E multiples have corrected by 30-40 basis points – again, a fraction of what we typically see when it comes time to start dipping more toes in the equity pool.

MKM Partners’ Jonathan Krinsky thinks the S&P 500 could be headed for 1,905:

We continue to harp on the market cap issue because we feel it is extremely important at the current juncture…There are many different ways to express this issue, but perhaps one that doesn't get enough attention is a simple ratio of the S&P 500 Equal Weight Index (SPW) vs. the regular market cap weighted SPX. This is the exact same index of course, just weighted differently.

This ratio has generally been in an uptrend for the last two years, during which time the S&P 500 hasn't so much as touched its 200-day moving average, or DMA. In the last few weeks however, this ratio not only broke its 200 DMA, but it has been making multi-month lows….weakness in this ratio has either coincided or preceded weakness in the S&P 500. This makes sense as it shows how money is moving up the market cap scale which is perceived as safer.

As we discussed in a note last week, there were some fairly oversold readings (% of stocks above 20 DMA) on the market which should have led to a relief rally, but we did not think that "THE" low was likely in. Based on the declining slope of the Russell 2k's 200 DMA, as well as the fact that the S&P 400 Mid-cap Index is now below its 200 DMA, we still feel that the August lows of 1905 on the SPX are in play. That would also roughly coincide with the rising 200 DMA (1903) which has not been tested in nearly two years. On an intra-day peak to trough basis that would still be less than a 6% correction off the all-time highs of 2019.

The upshot: The correction ain’t over yet.

Dark Pools Pervade Wall Street

I'm not usually the kind of guy to say, "I told you so."

But you know what? I'm saying it.

I told you so.

Dark pools - private markets unavailable to the public - and high-frequency trading are manipulative schemes run amok.

They weren't always. Both were the result of unintended consequences. But that's all behind them. In front of them now are civil and criminal lawsuits.

Late yesterday, New York State Attorney General Eric Schneiderman charged Barclays Plc. with fraud over how it markets its dark pool and how it operates it.

In a press conference yesterday after the market had closed, the AG said, "Barclays dramatically increased the market share of its dark pool through a series of false statements to clients and investors about how and for whose benefit Barclays operates its dark pool. Contrary to Barclays' representations that it implemented special safeguards to protect clients from aggressive or predatory high frequency traders, Barclays is accused of operating its dark pool to favor high frequency traders."

But that's not all Barclays did. Keep reading, and I'll explain all...

Dark Pools: Diving In

Barclays not only omitted pertinent information and facts about high-frequency traders' (HFT) access to their dark pool, but they falsified written material and presentation slides in a way that smacks of blatant fraud.

The promised protections were missing, among them limiting "predatory" players from the dark pool. And Barclays also allowed anyone into the dark pool.

Far worse, their own HFT desks were in the pool picking off clients.

The marketing material was obviously influential in attracting clients. Barclays' dark pool became the largest in the United States. There are some 50 dark pools operating in America - that's on top of 11 public exchanges.

And you can bet your bottom dollar there was money involved. According to market research firm TABB Group, the top three dark pools operated by Barclays, Credit Suisse, and UBS earned about $800 million in commissions in 2013.

That's just commissions, folks. There's no clarity on how much they made on their high-frequency trading, much of which was earned by reading their clients' dark pool orders and front-running them. My guess is that they made billions off their dark trading.

And here's what I'm predicting is headed our way next:

There are going to be more charges against more dark pool operators because they pretty much all work the same way. It's how the game is played. What's staggering to me is the stupidity of institutional money managers who go into these dark pools not understanding what the game is and how they're being teed-up.

As a result of what's coming to light (they should have just been reading my stuff all these years), money managers, on behalf of "the public" whose money they manage, mutual fund managers, pension asset managers, and hedge funds, too, are going to sue for the billions they've lost to this hand-in-glove scheming.

It's hand in glove because these money managers get you into their dark pools to protect you from high-frequency trader access and then front-run your orders.

They themselves are the wolves in the henhouse.

Maybe, just maybe, the end result of this will be that some of the inequities that have been built into the market systems we believe (well, not me, I don't believe) are fair and orderly and transparent might just become more so.

We all better hope so, because it's not just about fair and transparent. It's about how the market has been undermined and how it could collapse one day, literally, and trillions of dollars could be lost in a matter of days. And worse, whatever remaining confidence people have in the markets would evaporate and devastate U.S. capital markets and the economy.

If these schemes aren't wiped clean, and the market crashes because of the mechanical mayhem inherent in the operating machinery that we rely on, don't say I didn't tell you so.

More from Shah Gilani: The public has been hoodwinked by central banks and governments into thinking deflation is bad, when in fact it's a healthy corrective counterbalancing of excesses that build up in free-market economies. Here's the truth about deflation - and how the fearmongers are really screwing us over...