SET Monthly Issue June 2017
WHEN IT’S ALL ABOUT INCOME, WE’RE ALL IN
It’s like an early morning drive along Route 1 in Maine between Eastport and Lubec.
The fog is settled in so thick along the coast that even the evergreens lining the road are blurred.
You’ve got Janet Yellen and the Federal Reserve Board fixated on pushing interest rates higher, even though there’s little in the way of robust and sustained economic growth.
You’ve got a White House where despite the pro-business stance, there are questions about when the faster growth will appear.
And you’ve got a lot of expensive choices with stocks and bonds.
There are no easy answers, and all we know is that agility matters a lot right now. An investor needs to be ready to call an audible and make changes on the fly… without the benefit of a strategic plan.
We’re sick of driving through the fog and we’re admittedly a bit impatient.
We would like to beef up our income and add to our overall return with an ETF that isn’t as expensive as bonds and dividend stocks.
There is no such animal if you’re risk averse.
But if you’re willing to take on some risk, and allocate a modest portion of your portfolio to an ETF that can add some income without unreasonable risk, we’ve settled on a way to profit from emerging market debt.
It’s the VanEck Vectors J.P. Morgan EM Local Currency Bond (EMLC).
WHY WE LIKE EMERGING MARKET DEBT… IN SMALL DOSES
With 200+ countries around the world looking to borrow money, there are always scoundrels who never intend to pay any of it back. That’s why African thugs own estates in Villefranche Sur Mer and other enclaves along the French Riviera.
But emerging market debt has a long history of happy endings.
After all, U.S. Founding Fathers Ben Franklin and John Adams negotiated loans from France and The Netherlands.
So when we see a way to take a position in foreign market debt, and diversify our investment between countries, we’re onboard.
So we’ve settled on an ETF we believe makes sense for our portfolio right now.
AN ESCAPE FROM EXPENSIVE STOCKS AND BONDS
The VanEck Vectors J.P. Morgan EM Local Currency Bond ETF is a targeted way to profit from global growth… without investing in foreign stocks that are difficult to value because of foggy financial reporting.
The other consideration is the free-standing nature of this kind of investment. The interest rates and the returns we see from emerging market local debt are not directly tied to what happens with rates here in the U.S.
A 10-year Brazilian government bond now pays a 10% yield. This double-digit yield is clearly the premium that’s paid to take on risk, which in the case of Brazil means dealing with a government that is essentially corrupt and an economy that is still suffering through its most severe recession ever.
But Brazilian bonds represent less than 10% of the ETF’s assets. Risk is plentiful, but spread around.
THE TOP 5 COUNTRY BREAKDOWN
We usually show you the top stocks tracked by an ETF. For this investment, it’s better to look at the countries whose bonds EMLC invests in.
| Country | % Weight | ||
| Poland | 9.64% | ||
| Mexico | 9.42% | ||
| Brazil | 9.33% | ||
| Indonesia | 8.71% | ||
| South Africa | 7.55% | ||
| 05/10/17 | |||
THE MATURITY OF THE BONDS IN THE ETF
Maturity clearly matters. These days, short-term is good. But so is balance, and the ETF diversifies by term as well as by country…
| Term | % Weight | ||
| 1-3 Years | 21.20% | ||
| 3-5 Years | 21.04% | ||
| 5-7 Years | 15.11% | ||
| 7-10 Years | 20.29% | ||
| 10-15 Years | 12.19% | ||
| 05/10/17 | |||
PERFORMANCE
The ETF is now trading close to record highs, which would normally concern us.
Here’s why we’re not rattled by the price.
We should keep in mind that the moves of global markets can be extreme, quick to both rise and fall. Rarely do we see prices locked into a narrow trading range.
INSIDE EMLC
The VanEck Vectors J.P. Morgan EM Local Currency Bond (EMLC) includes debt from 17 countries. It’s the largest ETF for emerging market local debt and it’s been around since 2010.
The ETF has $3.35 billion in assets. The expense ratio is 0.47% and the current yield is 5.05%. Government debt represents 98.8% of the assets tracked debt, 0.7% is corporate debt and the balance is cash.
Since the beginning of the year, the ETF has been on a tear…
THE ROLE OF EMLC IN YOUR ETF PORTFOLIO
The question is how much of your portfolio you allocate to EMLC. It should not be considered a core holding, and it should be used by income investors to offset more secure, lower yielding positions with less secure, higher income.
We prefer to err on the side of caution and limit the size of the position.
We also see a scenario where we might have to beat a hasty retreat…
A SPECIAL CONSIDERATION
We always suggest a stop loss on our ETF recommendations, and we’re not making an exception for EMLC.
The rewards can be considerable, but the wheels could come off quickly. There could be an irrational, but very real domino effect.
A default in South Africa could trigger a sudden ripple effect that drags down the value of the ETF by unfairly poisoning perceptions of the safety of other countries’ bonds.
We recommend a trailing stop for your position. You can set trailing stops as either a dollar amount or as a percentage. Your specific risk level will determine exactly what kind of a stop you’d like to use. We’d go with something in the 4-8% range. Here’s why…
OUR CONCERNS
We’re always concerned about unforeseen events that jump out of the shadows. While France and North Korea capture headlines, and while bad actors like the Greeks cement positions as bad borrowers, we recognize that today’s dull market can become tomorrow’s hotspot.
A few years ago, investors looking at Europe couldn’t help but wonder, “What’s the next Greece?”
Just because there hasn’t been one doesn’t mean another meltdown isn’t about to take place. And while there’s a rosy feeling about Europe in the wake of recent French elections, who’s to say that Italy or Poland won’t suddenly go sideways?
Right now, if there is one in the top five that makes us nervous, it’s South Africa.
That’s because the government is playing fast and loose. President Zuma isn’t exactly a poster child for fiscal responsibility. He’s more likely to indulge in cronyism, patronage, and increased government spending. The result… lower grades from rating agencies for government bonds.
BUT… WE’LL TAKE THE INCOME
We’re cautious, and we’re onboard with VanEck Vectors J.P. Morgan EM Local Currency Bond (EMLC) with eyes wide open. When there is thirst for income that U.S. bond markets can’t quench, it only makes sense to look elsewhere.
And when we look for a decent yield, we can’t help but smile when we see the 5.05% the ETF pays.
Trade Alert
Buy: VanEck Vectors J.P. Morgan EM Local Currency Bond (EMLC) up to $19.25
Recent Price: $19.03
Price Target: $24.00
Stop Loss: Trailing stop of 4% – 8%
SECTOR SPOTLIGHT
52 WEEK SECTOR PERFORMANCE
| Consumer Discretionary | XLY | +13.01% | |||
| Consumer Staples | XLP | +10.87% | |||
| Energy | XLE | -13.42% | |||
| Financials | XLF | +1.03% | |||
| Health Care | XLV | +11.98% | |||
| Industrials | XLI | +9.24% | |||
| Materials | XLB | +8.01% | |||
| Real Estate | XLRE | +4.59% | |||
| Technology | XLK | +18.36% | |||
| Utilities | XLU | +11.41% |
PORTFOLIO UPDATE
. . . . Vanguard FTSE All-World ex-US Index Fund ETF (VEU) – HOLD
Last month’s recommendation has given up some recent gains, but is doing well, up 3% since May 2.
. . . . SPDR S&P Metals & Mining ETF (XME) – BUY
A nice rebound from recent lows. All we need for an uptick is an easing of uncertainties in China.
. . . . iShares MSCI Switzerland Capped ETF (EWL) – HOLD
The trend is healthy, and the ETF continues to perform well, up 11% since our recommendation in March.
. . . . Vanguard Mid-Cap Index Fund Investor Shares (VIMSX) – HOLD
We have been expecting a correction for mid-caps but so far, nothing rough.
. . . . SPDR S&P Pharmaceuticals ETF (XPH) – HOLD
At the end of January, pharma stocks took off. Since then, trading has been choppy, with the ongoing uncertainties of how possible changes to the Affordable Care Act will impact drug prices. We’re sitting on a 4% gain, and we’re happy to hold.
. . . . Vanguard REIT ETF (VNQ) – HOLD
Interest rate hike concerns have been throttling the performance of the Vanguard REIT ETF, but income isn‘t a problem. The dividend yield is a solid 4.41%.
. . . . PowerShares Dividend Achievers ETF (PFM) – HOLD
The Dividend Achievers are churning away. Yield is 2.24% and the ETF is up 11% since we added it to the portfolio in November.
. . . . First Trust ISE Global Engineering & Construction Index Fund (FLM) – BUY
When does all the money start to flow out of Washington into massive construction projects? Tough to say, but the ETF is performing like checks are already being cut and ground is already being broken. The ETF is up 11% since we added it to the portfolio in October. Yield is 1.83%.
. . . . Vanguard High Dividend Yield ETF (VYM) – BUY
Current yield is 2.81%. No significant performance changes.
. . . . Utilities Select Sector SPD (XLU) – HOLD
No changes. Continue to hold. This ETF remains a core position.
Portfolio Changes
- Buy VanEck Vectors J.P. Morgan EM Local Currency Bond (EMLC)
Category: SET Monthly Issues
