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CLS: Italy/Geopolitics and Markets/Recent ETF Developments

08/12/2014

Week in Review
Despite a broad sell-off in many international markets, domestic stocks and bonds managed small gains this past week, with the broad-based Russell 3000 index gaining half a percent. The 10-year U.S. Treasury yields reached their lowest levels since June of 2013, as investors sought safety, despite generally stronger U.S. economic data. Underlying the volatility this week was plenty of good news. U.S. jobless claims reached their lowest 4-week moving average since 2006, a gauge of U.S. services reached its highest since 2005, and foreclosures reached an 8-year low. U.S. headlines focused a lot of attention on merger deals falling apart, such as the potential Time Warner and Fox deal; however, both companies posted stronger than expected earnings last week. Globally, Chinese exports rose 14.5% annually, a positive sign for the global economy as strong demand for goods produced in China came from the U.S., Europe, and Southeast Asia.

Italy
Italian GDP this week showed that the country is technically in another recession, after two consecutive quarters of contraction. Italy is quite familiar with recession, as the economy has had only one quarter of positive GDP growth since mid-2011. Expectations were for growth of 0.2% during the second quarter, and accordingly, another negative figure surprised many investors. It is worth noting that the final reading on GDP isn’t due out until the end of the month, which will show a statistical breakdown of the underlying components of GDP, offering more insight.Italy is part of the European periphery, or what some call the “P.I.I.G.S.” These nations (Portugal, Italy, Ireland, Greece, and Spain) have been the key culprits of the European debt crises. However, as CLS has noted extensively, they also present some of the best value in Europe, if not the world. The Eurozone is a diverse group of countries and cultures, linked by a common currency. One of the key reasons to diversify is to avoid single country risks, such as what has occurred in Portugal and Italy lately. For instance, Spanish GDP was released recently and showed 0.6% growth, exceeding expectations and illustrating the benefits of diversifying across Europe. Also, in more positive news, Eurozone retail sales rose 2.4% year-over-year, the largest increase since 2007. Eurozone PMI also rose to a three month high. Our Risk Budgeting methodology helps to control the amount of risk we take in single countries and regions, but also provides us the opportunity to take advantage of attractive valuations and economic recovery.

Geopolitics and Markets
Turning on the news, it seems as though the world is falling apart – battles across the Middle East, threat of further Russian force, and a deadly virus causing widespread panic. For the most part, many of these types of events have been occurring all through our history – whether it’s battles across the Middle East, military invasions, or bird flu. Many point to the proliferation of information through technology as a key culprit in the quick spread of bad news, which definitely has some truth. Either way, it’s a good time to remind investors of the impact of geopolitical events on the markets.Lately, several studies have shown that the impact from geopolitical events on markets is very short-lived, and almost always creates a buying opportunity. In fact, a recent study showed that the only geopolitical event since 1950 to cause even a “medium-term” impact on markets was the Israeli-Arab war of 1973, which led to a Saudi oil embargo and quadrupling of oil prices in the U.S. It is also worth mentioning that the current “war zone” countries only represent 3% of worldwide GDP, and 0.7% of global market capitalization. Geopolitics fills up news feeds and media channels, but does nothing for investors except create more buying opportunities.

Recent ETF Developments
Exchange Traded Funds (ETFs), are a cornerstone of CLS’s portfolios. They are also an ever-changing and booming part of the financial world. Let’s discuss what we have seen so far in the first part of the year in ETF land.

As of July 1, ETF assets have grown to over $1.8 trillion. There are currently 1616 exchange traded products listed (ETFs and ETNs), 101 of which were launched this year. Some of the more notable and asset-gathering launches have been focused on yield-generating assets, such as short-term bonds, MLPs, and variable-rate fixed income. One of the trends lately in new ETFs has been dividend growth and quality focused ETFs. One of our key investment themes for the last two years has been a focus on quality assets. This has been reinforced by the recognition by ETF providers that quality is important for investors to focus on in this market environment.

Another important  development has been the filing for “nontransparent active ETFs.”  Many large mutual fund companies have filed for this exemption, which would allow for holdings of the funds to only be shown on a monthly or quarterly basis, rather than every day like traditional ETFs. This is still awaiting approval from the SEC.

And last, but not least, just last week a pair of ETFs were launched based on high yield credit default swaps (CDS). Credit-default swaps are essentially insurance contracts on bonds. While CDS is almost a bad word post-financial crises, when used effectively, these can be tools to mitigate credit risk in portfolios, but only time will tell if they are truly effective and efficient at doing so.

 

 

The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change.  No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC.  Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such.  All opinions expressed herein are subject to change without notice.  This information is prepared for general information only.  It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report.  You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recom¬mended in this report and should understand that statements regarding fu¬ture prospects may not be realized.  You should note that security values may fluctuate and that each security’s price or value may rise or fall.  Accordingly, investors may receive back less than originally invested.  Past performance is not a guide to future performance.  Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk.  These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.The S&P 500® Index is an unmanaged composite of 500-large capitalization companies.  This index is widely used by professional investors as a performance benchmark for large-cap stocks.  The Russell 3000 Index is an unmanaged index considered representative of the U.S. stock market.  The index is composed of the 3,000 largest U.S. stocks. The Russell 2000® is an index comprised of the 2,000 smallest companies on the Russell 3000 list and offers investors access to small‐cap companies. It is a widely recognized indicator of small capitalization company performance. The iShares MSCI Emerging Markets ETF is an exchange traded fund which seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of publicly traded securities in emerging markets, as represented by the MSCI Emerging Markets Index. The MSCI EAFE International Index is a composite index which tracks performance of international equity securities in 21 developed countries in Europe, Australia, Asia, and the Far East. The MSCI All-Countries World Index, excluding U.S. (ACWI ex US) is an index considered representative of stock markets of developed and emerging markets, excluding those of the US. The Barclay’s Capital U.S. Aggregate Bond® Index measures the performance of the total United States investment-grade bond market. The Barclay’s Capital 1-3 Month U.S. Treasury Bill® Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. The Equity Baseline Portfolio (EBP) is a blended index comprised of 80% domestic equity (represented by the Russell 3000 Index) and 20% international equity (represented by the MSCI ACWI ex US Index), rebalanced daily. An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general.  You cannot invest directly in an index.  An ETF is a type of investment company whose investment objective is to achieve the same return as a particular index, sector, or basket. To achieve this, an ETF will primarily invest in all of the securities, or a representative sample of the securities, that are included in the selected index, sector, or basket.  ETFs are subject to the same risks as an individual stock, as well as additional risks based on the sector the ETF invests in. Bonds are a type of debt instrument issued by a government or corporate entity for a defined period of time at a fixed interest rate.  Bonds may be subject to unsystematic risks including, but are not limited to, call risk and reinvestment risk.  High yield bonds, or junk bonds, will be subject to an even greater degree of these risks as well as subject to the credit risk. International investing is an investment strategy where investors chose global investment instruments.  International investing can be accomplished utilizing a variety of investment vehicles including, but not limited to, ETFs, American Depository Receipts, or a direct investment in a foreign stock exchange.  Diversifiable risks include, but are not limited to, political risk and currency risk.
1603-CLS-8/11/2014

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