Christine Benz: Hi. I'm Christine Benz for Morningstar. Stocks have continued to sell off sharply this week. Here to discuss what's driving the weakness as well as whether it's created any pockets of buying opportunities for long-term investors is Scott Burns. Scott is a research director here at Morningstar. Scott, thanks so much for being here.
Scott Burns: Christine, thanks for having me.
Benz: So, Scott, first of all, S&P came out with this ratings downgrade for U.S. Treasuries on Friday night. I'd like your take on what the implications of it are and whether you think that that's the thing that's putting downward pressure on stocks right now?
Burns: Right, well, it was definitely a headline-grabbing move. I don't think it was really surprise to anybody. I think we had been seeing a lot of movement in that direction. In fact, just last week or the week before, the Chicago Mercantile Exchange, one of the largest of futures and options markets, had actually started to require investors to haircut their Treasuries in collateral by 5 basis points. So we had already seen the kind of actual downgrade going through right now.
Whether it's AAA or AA+, I don't think it necessarily really matters. It's still the biggest pool of investment-grade securities out there for people to use as collateral, but I do think there is a psychological effect going on right now with the downgrade. But at the end of the day Monday, markets were selling off again in the equity market and Treasuries were rallying after the downgrade. So, to me, that says that it's really more about the eurozone debt crisis and, frankly, I think more about the economy with some of the mixed economic numbers that we've been getting.
Benz: The economy here in the U.S. as well as in developed foreign markets?
Burns: Right, and it rolls through everything. So, I think the one number really to keep an eye on was that inventory number. What we had in 2008 and 2009 were corporations which cut their manufacturing to the bone so much that we actually had a shortage for a little while. We had to rebuild some of those stocks and those inventories.
As that started to flatten out now, what we're seeing is kind of that real economic demand, and things are flattening out. I'm concerned about inventories in general but the autos sector more in particular. So, one effect of the downgrade that it's going to have, whether psychological or real, is that costs of borrowing are going to go up. In fact, what the CME really did is a margin call on everybody. That was just a broad-based margin call.
If you have the mutual fund that owns futures or options that trade through the CME, the cost of those just went up. If you're investing in a fund or you have someone else who is borrowing money from somewhere else, their cost have gone up and therefore your returns have gone down.
So, a lot of what we're seeing I think is actually just the effects of "little i", which is the risk-free interest rate, and one of the axioms of finance theory is that "little i" is the biggest lever in everything. So, if "little i" goes up, all asset prices must go down. "Little i" is in CAPM; it's in Black Scholes. It's in every asset-pricing model.
Benz: We have seen with this recent sell-off that some of the more cyclically oriented companies have sold off the hardest as well as small caps have really taken it on the chin?
Burns: Yeah. We've really seen and this, again, it echoes November of '08 and even March of '09 to a certain extent this kind of flight to quality. While Treasuries are still going up and people are scratching their heads about that, maybe it's just the best pig in the poke right now. So, it's definitely the deepest. But we've also seen value large-cap U.S. stocks that are globally diversified holding up better than that small cap and that mid cap; we've definitely have seen a much more outsized flight to quality in those areas of the market.Read Full Transcript
Benz: So, you've helpfully brought along some picks today, and to start with, you wanted to talk about some safe havens that people could look to right now. Some of them are a little counterintuitive, so let's start with one. It's a Swiss franc currency exchange-traded fund.
Burns: Right. I rarely, almost never recommend currency ETFs, and when I'm out on the road I get asked questions, such as "What do you think about the Swiss franc?" And I usually answer I don't think about the Swiss franc.
Benz: Unless you're in Switzerland?
Burns: Yes, unless I'm in Switzerland. But in all this kind of global downturn, I mean there is one name that keeps coming up, the ticker that we like in particular is FXF. That's a Swiss franc currency ETF where basically, you give them your money, and they take your money and stick it in a Swiss bank account, right and that's your return, your return is the currency and whatever the Swiss franc risk-free rate is yielding at that time.
It's had a very nice run rate now, and frankly, we think that there is kind of a supply and demand benefit to this right now, that there are so many people who are looking to diversify away from the dollar. And there are just not as many Swiss francs as there are dollars and so, we think that that this will continue to run.
Benz: A kind of a momentum effect?
Burns: Definitely, a continued momentum effect. So, in the portfolio, you want to think about these currency funds as cash substitutes because you're really only going to get a cashlike yield. I mean the currency appreciation has looked a lot more equitylike.
Burns: Given some other things that have been happening to the money as you look at it as a U.S. investor, it's maybe not so much what's happening with the Swiss franc, it's more what's happening with your dollar.
Benz: Right. So, as the dollar has declined, that has translated into higher returns for people who have Swiss franc-denominated securities?
Burns: Exactly. But at the end of the day, the fundamental is it's a savings account return. So you want to think about it that way in your portfolio.
Benz: Right, but I would argue, too, you probably don't want to supplant all of your cash investments with something like this because you are getting a healthy dose of currency exposure there, as well?
Benz: Another idea, I think it's really interesting. It's a Nuveen Municipal Bond closed-end fund trading at a nice discount, and it also has a nice yield. Let's talk about what you like there?
Burns: Yeah. So, it's the Nuveen muni value. The ticker on that is NUV. Our analysts give it a superior rating from the management perspective. The discount right now is at 6.2%, which is well below its six-month and three-year average. So, we're getting it at a nice price. The distribution rate, which is all income, which you always have to keep an eye on for closed-end funds, is around 5%. So when we are looking at 10-year Treasuries yielding 2.5% and this is a non-tax adjusted 5%, that's a pretty rich yield right now for a very diversified fund that's done very well over time.
Benz: Nuveen, of course, is a big name in that space.
Benz: One thing I want to touch on with you, Scott, is gold, and gold has been going through the roof touching new highs just recently. What's your take on people looking to gold as a safe haven at this point?
Burns: Well, there is no arguing that gold, as a safe haven, has performed that role to date, and it's been a tremendous performer given how bad everything else has been doing. In fact, we actually about six months ago, put a specific allocation to IAU iShares Gold in our Hands Free portfolio. Right now though with futures touching around $1,700 when I walked down here to the video studio, it's hard for us to recommend buy more gold. That's not to say that if you have it, we are recommending getting rid of it. But the price is getting a little frothy right now. Gold's kind of a tricky thing. It's really hard to always kind of fundamentally justify that value.
Benz: Well, that's a thing, it's hard to know whether it's frothy or not, right.
Burns: So it's frothy on a technical basis, we'll go with that. Nobody can really say what is on a fundamental basis, but as gold is going up and usually, you know, you look at other commodities relative to gold. Oil is going down, right? So I think even for the Armageddoners out there, would you rather have a barrel of oil or a bar of gold should things come to pass? I mean I would definitely think oil. So we are going to keep an eye on that oil-gold relative-value split, and that I think will end up being one of the better predictors of that frothiness overall.
Benz: So stepping out on the risk spectrum a little bit, you have also brought some ideas for people who want to take advantage of companies that have been unduly beaten-down during this recent sell off. Let's look at some of those.
Burns: Yeah. So we'll classify these as overblown risk, but still we think a pretty good return. Call me crazy, I may regret this, but we'd like to recommend EWG, which is the iShares MSCI Germany Index. Germany has really taken a pounding in this whole downturn. I think its exposure to Greece is pretty well-known, but its down 17% in August. This index is really dominated by large industrial names like Siemens, Daimler Chrysler, and also the big banks. So there is a lot of industrial risk and a lot of financial risk. We think 17% down in a week is an awfully steep price to pay for this. It's trading again very similar to the S&P 500 and around 12 times trailing P/E. So we think for those who were looking again for that kind of overblown risk and a good value, we like Germany.
Benz: Then some of the higher-yielding companies based here in the U.S., mainly, also look relatively attractive, I know, to our stock analysts. Do you think that translates into some opportunities for ETF investors, too?
Burns: Definitely. There are two that we really like right now. One is Vanguard High Dividend; the ticker is VYM. It's sporting a 2.8% yield right now. The 10-year Treasury is around 2.5%. So, historically, it's generally a good idea to buy stocks when the dividend yield is higher than the 10-year Treasury yield. That's a good idea.
I know Tim Strauts on my team talked about the iShares High Dividend Equity ETF; HDV is the ticker. Right now that's got a 4% dividend on it. So, both of these are ETFs that tilt toward dividend paying. There are still some financials in there; there are some other risks embedded. But we definitely think in a sideways market like the one we think we are going to have for the next few months, if not years, getting paid to wait is kind of the smart way to play it. For full disclosure, Morningstar does provide the index for the iShares High Dividend Equity ETF.
Benz: So stepping out a little bit on the risk spectrum, you are also looking at a China closed-end fund. Do you think the risks there have been a little bit overblown? You think the shares underlying it are oversold? Let's talk about that one.
Burns: Yeah. So we are looking at China Fund with the ticker CHN. I think the, There is some slowdown there, but I think biggest risk with China right now is that they've got a dead-beat as a debtor for them and it just happens to be the U.S. But right now, this fund is trading at a 21% discount. It's all-time low for the fund, trading well below what its average discounts are. It's diversified across a lot of Chinese sectors. So for folks who're looking to capitalize on maybe some of this China pullback right now definitely take a look at this closed-end fund, you can buy China and buy it at a discount, as well.
Benz: So, now let's step out even further on the risk spectrum into some picks that you categorize as high-risk but also high-return potential. These are definitely things to use around the margins of peoples' portfolios versus making centerpieces, but let's talk about some of those ideas.
Burns: Yeah. We think emerging markets have really sold off quite a bit. They've had a great run. We like DEM which is the WisdomTree Emerging Markets Income fund. That's got a current yield of 6.7%. Probably the biggest risk part of this is that 27% of the fund is in emerging-markets financials. So depending on whether the contagion spreads or not, that can be a bad thing. If it doesn't spread, we really look for good things out of this fund.
We touched on gold earlier. Our other kind of high-risk, high-return idea would be the Central Fund of Canada, CEF, which is the best closed-end fund for playing gold. It's been up 63% during the last year. The NAV is up 70%. So it's definitely been trading at a little bit of a discount here. So, again, gold, as we've said, it's hard to say "sell it," but I do think if you are looking for a high-risk, high-return opportunity in gold, Central Fund of Canada looks pretty attractive right now.
Benz: Well, thank you Scott for sharing those ideas. We really appreciate your insights.
Burns: Well, thanks for having me. I wish it were for better news.
Benz: Me too. Thanks for watching. I am Christine Benz for Morningstar.