SET Monthly Issue July 2017

| July 3, 2017


Our thirst for ETF investments that deliver solid income has been partially quenched over the past few quarters.

We’ve been focusing on investments where we can get a good night’s sleep and a good income.

But our thirst isn’t fully quenched.  We’re still on the hunt for dividends to either reinvest or put in the bank.

And that’s why we’re looking at banks, the big, global banks where stock prices have been ablaze since President Trump’s election.

Our current ETF portfolio is built around diversified sources of income, and now, we are complementing this with The Vanguard Financials ETF (VFH).


The Financials ETF tracks the performance of the MSCI US Investable Market Index Financials 25/50.  This is where you’ll find a mixture of big U.S. banks, along with a handful of companies like Berkshire Hathaway, which holds a sizable position in Wells Fargo.

Investment banks such as Goldman Sachs are also tracked, along with financial companies like Chubb, American Express, and AIG.

The expense ratio is 0.10%.  Holdings are concentrated in the U.S., although major U.S. banks are doing business globally.

411 stocks make up the index.  Roughly 30% of the value is concentrated in the top 5 holdings.


It’s all about the rising tide of rates.  When interest rates go up, so do bank stocks.  The timing of the two moves don’t always go hand in hand, but the connection is indisputable.

So, when we look at making an investment where interest rates play a larger than normal role, we can’t help but wonder…


Bank stocks were some of the biggest winners in the post-election rally, but there’s been a cooldown.  Bank stock prices peaked in March and since then they have been drifting lower.

Does this mean there’s trouble ahead?  If tax reform doesn’t happen, and if regulatory reform stalls, are banks still saddled with burdensome federal restrictions?

We don’t believe either issue will significantly impact the financial performance of big banks.

The impact of the so-called stress tests, where regulators look at the cash reserves banks stash in their vaults to offset the risk of loans turning sour, has now become less of a bone chilling event for bankers.

Last week, the Federal Reserve handed out a passing grade to all 34 financial institutions it sizes up for financial health.  This was the first solid green light since the stress tests began in 2011.

The days of The Dodd Frank Act haven’t passed, and it’s not unusual to see 20% of a bank’s employees working on regulatory compliance issues.

But we believe the softening sting of stress tests will prompt banks to crack open their vaults.  One of the results of this… more money shoveled into dividend payments.

Right now, when we look at the dividend payout ratio, which is the percentage of quarterly profits banks allocate for dividends, here’s what we see…

  • Wells Fargo: 5%
  • JP Morgan Chase: 1%
  • Bank America: 6%
  • Citigroup: 12.2%

Breathing room could easily open for the banks to reward investors with fatter dividends, and this could happen before the end of 2017.

When dividends grow, it’s not unusual for the share price to grow as well.  And when the market takes a breather and retreats, we usually see dividend stocks, particularly stocks with growing dividends, hold up better than the overall market.

Another possible development… stock buybacks.  Don’t be surprised to see the big banks announce buybacks.

But this doesn’t mean an automatic Christmas gift for investors.  The history of Wall Street is littered with buybacks that are announced but never happen, or happen at reduced levels.

And while buybacks create demand which can push a stock price higher, it’s not a direct, measurable benefit to the shareholder.  Dividends put money in the bank – buybacks may or may not.


Company Name Sector % Weight
JP Morgan Chase & Co. (JPM) Financial 8.75%
Wells Fargo & Co. (WFC) Financial 7.04%
Bank of America Corp. (BAC) Financial 6.44%
Berkshire Hathaway Inc. B (BRK-B) Conglomerate 5.83%
Citigroup Inc. (C) Financial 4.95%

JP Morgan Chase & Co. (JPM)

Founded in 1799, the firm operates globally.  Major divisions include Consumer & Community Banking, Corporate & Investment Banking, Commercial Banking, and Asset & Wealth Management. 

Wells Fargo & Co.  (WFC)

Wells Fargo has offices in 42 countries, 8,600 locations, and 13,000 ATMs. The firm provides diversified financial services.  Core businesses include retail, commercial, and corporate banking services.  The wholesale banking segment offers commercial loans and lines of credit, letters of credit, asset-based lending, foreign exchange, and other services.  

Bank of America Corp. (BAC)

Bank of America operates 4,600 financial centers, 15,900 ATMs, call centers, and online and mobile platforms.  Markets include consumers, small and middle-market businesses, institutional investors, large corporations, and governments.

The bank’s four segments are Consumer Banking, Global Wealth & Investment Management, Global Banking, and Global Markets.

Berkshire Hathaway Inc. B (BRK-B)

Warren Buffet’s conglomerate has a major holding in Wells Fargo… it is the bank’s major shareholder.  Buffet started buying the stock in 1989.

The latest filings indicate the firm holds 479 million shares worth more than $28 billion.

Citigroup Inc. (C)

Citigroup Inc. provides financial products and services for consumers, corporations, governments, and institutions.  One holding is Citicorp and the other is Citi Holdings.

The Citicorp segment offers traditional banking services and operates 2,649 branches in 19 countries.  Citi Holdings makes consumer loans and manages a portfolio of securities, and loans.


The Vanguard Financials ETF is a modest but dependable income workhorse, and as we’ve noted, it should be throwing off even more income in the months ahead.  The current yield is 1.67%.

Don’t look for significant capital gains through the growth of the share price.  After all, the ETF went from less than $50 to $60 in November, so the days of big surges are probably behind us.

This doesn’t mean we won’t see more growth.  And it doesn’t mean this is an expensive investment, because the Vanguard Financials ETF trades at a lower P/E ratio than the S&P 500.

Look at VFH as a source of growing income.  But don’t bank on it as a long-term hold, like our Utility ETF.  By nature, bank stocks are cyclical.  Watch VFH, because it can easily go through dizzying ups and downs.  Here’s how the ETF has performed since it launched in 2004…

The Vanguard Financials ETF

When will the time come to sell VFH?  Here are a few things to keep in mind…


The yield curve is the gap, the difference between short term interest rates and long-term interest rates.

The tighter the gap, the tougher it is for banks to make money.  That’s because they make loans for the long term but borrow for the short term.  Now that rates are going up, banks will benefit because the interest they pay out to depositors will not go up as quickly as the rates they’re able to charge for loans.

It’s also smart to keep an eye on unemployment and inflation, which make up the Federal Reserve Board’s Dual Mandate.  This is the heart of the policy machine that drives interest rates.  The Fed wants to see maximum employment (a highly debatable number) and stable consumer prices.

Low oil prices have been keeping gasoline prices low.  An uptick in oil prices, which have once again been beaten down, could easily stir up inflation and push interest rates higher.

How much do higher rates help big banks?  A lot.

Earlier this year, JPMorgan Chase revealed that the Fed’s rate increase in March, would deliver a $400 million net interest income bump in Q2 over Q1.

Trade Alert 

Buy:  The Vanguard Financials ETF (VFH) up to $64.00

Recent Price:  $63.39

Price Target:  $72.00

Stop Loss:  $58.00 




Consumer Discretionary XLY +10.11%
Consumer Staples XLP +6.25%
Energy XLE -13.81%
Financials XLF +6.11%
Health Care XLV +14.94%
Industrials XLI +9.47%
Materials XLB +8.27%
Real Estate XLRE +4.72%
Technology XLK +13.15%
Utilities XLU +6.98%



We are going to take some profits and trim 3 positions from the portfolio.  The reason for each move is the same:  protection for a possible market reversal, and to lock in gains.

We would not be surprised to see each of these 3 ETFs increase in value, but given the gains they have provided, and our preference for prudence, we’re happy to leave some money on the table.

. . . . VanEck Vectors J.P. Morgan EM Local Currency Bond (EMLC) – BUY

There’s been a slight slip in the value of the ETF over the past few weeks, but the job we’re looking for EMLC to do is to generate income.  The current yield is 4.95%.

. . . . Vanguard FTSE All-World ex-US Index Fund ETF (VEU) – BUY

There’s been a modest 2% increase since our recommendation in May.  Current yield is 2.61%.

. . . . SPDR S&P Metals & Mining ETF (XME) – BUY

On June 21, the ETF traded at $28.02.  Since then, XME has stormed back, and is just below our buy price.  Acquire more shares at this favorable price.

. . . . iShares MSCI Switzerland Capped ETF (EWL) – HOLD

The ETF’s largest holding is Nestle, and recent rumblings from an activist investor have been the source of stock price volatility for the food company.  EWL has delivered double digit gains since our buy recommendation in March.  Current yield is 2.32%.

. . . . Vanguard Mid-Cap Index Fund Investor Shares (VIMSX) – SELL

One of our three sell advisories… an opportune time to lock in 5% in profits. 

. . . . SPDR S&P Pharmaceuticals ETF (XPH) – SELL

One of our three sell advisories… an opportune time to lock in 8% in profits. 

. . . . Vanguard REIT ETF (VNQ) – HOLD

Little change.  A sluggish stretch continues for real estate assets, so we’ll pocket the 4.44% yield.

. . . . PowerShares Dividend Achievers ETF (PFM) – SELL

One of our three sell advisories… an opportune time to lock in 10% in profits. 

. . . . First Trust ISE Global Engineering & Construction Index Fund (FLM) – HOLD

Double digit returns, and we’ll continue to hold.  We’ll patiently await whatever infrastructure spending plans the Trump Administration plans to put in place.

. . . . Vanguard High Dividend Yield ETF (VYM) – HOLD

On May 17, the ETF traded at $75.80.  We chose not to sell, and today, VYM closed at $78.50.  Current yield is 2.94%.

. . . . Utilities Select Sector SPD (XLU) – HOLD

No changes.  Continue to hold.  This ETF remains a core position.

Portfolio Changes

  • SELL Vanguard Mid-Cap Index Fund (VIMSX)
  • SELL SPDR S&P Pharmaceuticals ETF (XPH)
  • SELL PowerShares Dividend Achievers (PFM)
  • BUY Vanguard Financials ETF (VFH)

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