Buchanan Advisory Services

A Blog about Stocks

ETF Spotlight ft. (SPDR)

SPDR S&P 500 ETF or SPY is an exchange traded fund that reflects the performance of the S&P 500. SPY has a 52 week range of 233.76 - 302.46, and a YTD return of 21%. Investing in the S&P 500 is viewed as a viable and safe way to put money away for retirement(see figure 1 for performance of S&P 500). SPY can be purchased on any trading platform such as Robinhood, TD Ameritrade, or Charles Schwab.

SPY's Monthly Return Statistics

SPY has an average return per month at 0.84% with a standard deviation of 4.15%. We can also conclude with 95% confidence that the monthly return for SPY will be between -7.2% and 8.9% return.

Worst Monthly Return in SPY History (October 2008)

The worst monthly return ever recorded in SPY history happened at the peak of the financial crisis of 2008. The return for the month of October rested at -16%. Thankfully a return this poor is not likely. There is a .000024% chance of a fat-tail event like this to happen again.

Figure 1(S&P 500 Performance)

What would happen if you invested $500 monthly into SPY for 30 years?

After 100 simulations based on random possible returns of SPY on average after 30 years you will have $1,129,712 after an investment of just $180,000. We can say with 95% confidence that your returns after 30 years will be between -$223,905 and $2,483,330. Basically we can say with 95% confidence that your returns will land in the range above.

Recommendation

After studying the upsides and downsides, I would highly recommend this ETF to my client. Since SPY directly follows the S&P 500 there is not as much risk involved as one may think, the market has always recovered and grown. This fact along with the simulation in which on average with a $180,000 investment you will have $1,129,712 after 30 years of investing into SPY I can conclude that SPY is a low risk ETF that would be an excellent source of a retirement fund.

Why Diversifying is the most effective way to Invest

 Previously, we talked about SPDR S&P 500 ETF or SPY. To review, SPY is an exchange traded fund that reflects the performance of the S&P 500. SPY has a 52 week range of 233.76 - 302.46,a mean monthly return of .007% with a standard deviation of .04% and a YTD return of 21%. Investing in the S&P 500 is viewed as a viable and safe way to put money away for retirement.

Today we will introduce another ETF, BND.

BND is a Vanguard Total Bond Market Index Fund with a 52 week range of 77.46-85.30, with a mean monthly return of .003% and a standard deviation of .01% and a YTD return of 8.32%. Investing in BND is seen as a low risk low return investment.

What is EEM?

EEM is one of the oldest, most established ETF's that focus on emerging markets. Since it does not correlate perfectly with U.S. equities and bond markets, it is a great way to diversify. EEM  has a 52 week range of 37.58-44.84 with a mean monthly return of .000588 with a standard deviation of .06772, and YTD return of 7.47%.

Optimal Risky Portfolio

After some calculations the higher return can be achieved by having a mix of SPY and BND. The highest Sharpe ratio(or bang for your buck) was recorded at .268 with a .14 allocation in SPY and a .86 allocation in BND.

Why Diversify?

After throwing in EEM into the calculations it can be concluded that diversifying is better. With a Sharpe ratio of .29 with allocations to EEM(.10), SPY (.32), and BND (.58) we can conclude this is the most optimal portfolio. Diversifying mitigates the risk of your portfolio as you hold stocks in different sectors of the economy. Along with this when one sector is not performing well another might be and this will allow your portfolio to remain growing at a constant rate. It can be concluded that diversifying your investment into SPY, BND, and EEM is the most optimal risky portfolio that will offer the highest returns at an acceptable risk.

Leveraged ETF's and the relationship between the market and Berkshire Hathaway

What is SDS and SSO?

SDS is an Ultra Short of the S&P500. It has a 52 week range of 28.75-49.47 with a YTD return of -28%. SDS has an average return per month of 10%(some major outliers contribute to this) with a std of 72% from 2014 to 2019.

SSO is an Ultra S&P 500 ETF. It has a 52 week range of 81.39-133.46 with a YTD of 34.44%. SSO has an average return per month of .017 and a std of 7% from 2014 to 2019.

How Does Berkshire Hathaway Performance compare to the market?

2009-2013

Beta=.50

Avg. return=.9%

2010-2014

Beta=.45

Avg. return=1%

2011-2015

Beta=.75

Avg. return=1%

According to my calculations Buffet's reputation is not completely justified, but not necessarily in a bad way. With the Beta being well below 1.0 volatility is very low, but so are gains. I will also say this is a small sample size of Berkshire Hathaway and we might obtain a better perspective by tracking growth from the beginning until now. In other words although this form of measurement is not the most impressive other forms might show better results. This does however give a peak into Buffet's style of investing as the years go on, low risk, low reward.

Recommendation

VB is a great way to diversify a long term portfolio. With a positive economic alpha it follows the U.S. economy enough to where it is a safe investment. Along with this it allows for enough diversification from a typical S&P 500 ETF such as SPY. This will allow the investor to gain exposure to small businesses in the U.S. further diversifying your portfolio.

What if we combined SDS and SSO?

If you were looking to have a Beta of 1.5 a good mix would be 7% into SDS and 93% into SSO. Although allocating your portfolio in this way does carry risks. When the market is not performing well you are not getting much of the benefit of SDS, but when the market is doing well SSO will prop up your portfolio. Essentially this is a relatively safe bet because the market will gradually grow over time and owning SDS will protect your portfolio from being as volatile in times of recession.

Vanguard Small index funds and The Three Factor Model

What is VB?

VB is Vanguard Small-Cap Index Fund which tracks the performance of small US companies. It has a 52 week range of 123.80 to 160.88 and has a YTD return of  17.77%. VB is seen as a great way to diversify long term investments as opposed to allocating your entire portfolio into an S&P 500 fund. VB has a mean monthly return of .5% compared to SPY's at .8%. SPY has a 4% standard deviation, while VB has roughly a 5% standard deviation. This can be contributed to the fact that smaller companies are more volatile when dealing with economic conditions. 

The Three Factor Model

VB does in fact have an economically significant alpha. This is important because an economically significant alpha shows the ETF closely follows the U.S. economy. This is essential because although the U.S. economy hits dips, in its' entire history it has always grown at a relatively fast rate.

Does LSVEX live up to the hype?

What is LSV and DFA?

LSV is a value equity fund that focuses on value stocks. It has a 52 week range of roughly 23.19 to 26.35 with a YTD return of 14.33%.

 

LSV has a few rules it abides by when picking stocks. LSV looks for stocks that might have disappointed investors, but show signs of life or momentum in earnings or stock price. It immediately excludes any company near bankruptcy or one with less than two years of being public. On top of this it doesn't allow any one stock to make up more than 1.6% of the portfolio and no one industry to take up more than 3%.

DFA which follows the beliefs of Eugene Fama believes stocks are accurately priced at any given time because they reflect all information known to investors, they believe being any to pick stocks is an illusion. DFA sweeps many stocks into it's portfolio and only excludes those stocks that might be removed from the market. Once they are in the portfolio they are passively managed in order to keep fees down, an average of about 53 cents per $100 of assets. The results is low capital-gains tax and low fees, huge selling points for DFA.

LSV vs. SPY

SPY and LSV follow each other rather closely. LSV has an average monthly return of .0125 with a standard deviation of .048 and a sharpe ratio of .237. SPY has an average monthly return of .0129 with a standard deviation of .037 and a sharpe ratio of .314. SPY having the better sharpe ratio shows it is less volatile then LSV, hence why it has a smaller standard deviation on return, although they share nearly identical average returns.

Recommendation

LSV has Beta of .85 with a 3yTD beta of 1.20. This indicates the fund is more volatile than the market in recent years. Along with this the Alpha is -.00031. This shows it just barely misses the mark of beating the market. These indicators along with SPY having a better Sharpe ratio(less volatile) hint that LSV is not in fact a market beater. I would recommend my client to buy SPY instead of LSV because of less volatility, it being a safe investment, and a dividend reward for owning the ETF SPY.

Classic Investing Books along with lessons learned

Reminiscences of a Stock Operator

Summary

Lessons Learned

Reminiscences of a Stock Operator is a fictionalized account of the great investor Jesse Livermore, who is renamed as Larry Livingston in this book. The book opens up as Larry is just a young boy working in a bucket shop as the quote boy. A bucket house is where small bets are made against the rise and fall of stocks or commodities. Throughout his time as a quote boy he realizes that he has a knack for speculating prices and he begins to take notes and trade in these bucket houses. Eventually, he quits his job as a quote boy and he does very well, earning $1,000 by the age of 15. Livingston continues to trade in bucket shops but is eventually no longer welcome at bucket shops for his constant earnings. Larry then decides to leave for New York to try out real stock trading. Larry goes broke as he realizes that his smaller short-term bets do not work on actual trading. Livingston then goes to St. Louis in order to find bucket shops that do not know his reputation. He is only able to make a few thousand dollars before all the bucket shops no longer welcome him, so he moves back to New York. In New York he again loses his money, so he moves to Boston. Since he can no longer use bucket shops, he tries his hand into stock exchanges that are a bit unethical. Normally, these shops trick their clients into losing money, but Livingston flipped their game on them and took advantage. At this point, Larry goes back to Wall Street and finds a bit more success. Livingston realizes that overall direction of the stock market is much more important than short-term movement of individual stocks. Livingston makes his first million dollars by shorting on the bear market. The financial situation gets so dire in fact that J.P. Morgan and Livingston have to “save” the market. Instead of being bearish on the market Livingston agrees to buy stock and the market begins to rally. Larry at this point was very successful and decided to reward himself by buying a few yachts and going on a fishing trip. He begins to trade in commodities and loses a lot of money by ignoring his own trading principles and listening to “tips” by others. In this state of distress Larry sought to earn back his money so he forced trades in a time where making money was not in the cards at Wall Street. At this time Larry becomes disheartened, ill and flat out broke as he declares for bankruptcy. World War 1 eventually kicks off and he makes enough money to pay off his previous debts. At the end of his career Livingston becomes a “stock operator”, essentially a paid manipulator. Larry gets paid by a group of investors that are wanting to sell their stocks at a good price. Larry in return does not spread tips, but trades in the market in a way that gives other traders an impression that the stock will go up. Livingston later admits in his book that he believes this to be unethical and should be banned.

Throughout this book we learn many lessons from Jesse Livermore’s experience. One of the most unique things about this book is that it was made entirely off of Livermore’s real world experience with the market. In a time where there was no internet Livermore’s only teacher of the market was the market itself. Many of these lessons he learned 100 years ago still apply today. This is a great indicator that human behavior and the way we impact the market through our thoughts and emotions has not changed much.  

Throughout his story he had many great successes and many points of rock bottom; here are some of the lessons he learned. Throughout his failures on Wall Street he realized he can’t use the same strategy as in a bucket shop. He learned that “the trend is your friend” and you should be taking trades based on how the overall market is moving rather than short-term movement of individual stocks. In his process of trying to make money on Wall Street he tells us that “one can’t go broke taking profit” but also hits us with the dichotomy that “ you also can’t get rich taking 4 point profit in a bull market”. This shows a hint into his investing style and hints that in order to be a successful trader, you must have some risk in order to get adequate profit. Throughout his story we also get a picture into his thought process on individual stocks. Livermore explains that patterns tend to repeat themselves, and if you can’t adequately explain why a stock is behaving in a certain way, then you shouldn’t trade it. In the classic battle of emotions that investors face Livermore also learned some valuable lessons for Day traders. He explained many full-time traders feel like they HAVE to bring home money everyday, so they force trades. Livermore explains that “the requirement for constant actions causes losses”. This lessons mainly just tells us to do our research and only trade based on an opportunity rather than forcing one. Livermore unfortunately in the end also saw the dark side to Wall Street as well. He saw and was a part of stock manipulation. In being a part of this he explained that “a successful trader shouldn’t take tips from anybody and should act on their own thoughts and research”.

This book provides many lessons for the stock investor 100 years ago, and today. I highly suggest any investor to read, take notes, and learn from this book that is full of lessons that have already been learned.

Option Opportunity: Under Armour

Summary of this Opportunity

Under Armour recently has come under investigation for its' accounting practices. This news has caused the stock price to drop 15% in one day. This leads us with a binary outcome opportunity. The investigation can play in the favor of Under Armour and the price will recover, while negative news will send the stock plummeting. Under Armour has a very high year volatility at 38%. This leads for a potential for a good amount of money to be made. In particular we are looking at the date January 15, 2021 in order to have time on our side. Currently a strike at 30 will cost $45. and a put at 10 will cost $65. These were similar to my calculated prices but was still off. This can be because Sigma is very hard to accurately replicate. Along with this volatility is also hard to calculate. Implied volatility entails the volatility we have calculated and what is expected, while historical volatility is concrete numbers of past volatility that we can judge future volatility on. 

Recommendation

After further research and how Under Armour has handled the situation, I would recommend a put on the company. In the earnings call Under Armour only talked about this major issue for 30 seconds giving investors no confidence. Along with this as competition gets fiercer from companies like Nike and Adidas, Under Armour sales will continue to decline like they already have. I believe a long term put would be the best option in this scenario. As the investor you do have the choice though. With a strike price of 30 on a call the break even would be around 30.60 and every cent after that you would make one dollar. This is very similar to the profit calculations of a put at 10. Overall, I would suggest a long term put to investors as the competition ramps up in the sportswear department, there is signs Under Armour will continually decline.
 

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