Equifax, Plus Observations From the Morningstar ETF Conference
Thursday, September 14, 2017

The big questions on many people’s minds right now is what to do about the Equifax breach. Sensitive personal information—including Social Security numbers and birthdates—on 143 million consumers was stolen. The situation is still evolving, but Equifax is offering “free credit monitoring and identity theft protection” to all U.S. customers. Signing up for the service (which covers Equifax, but not other credit bureaus) will not waive your right to take legal action. (A class-action lawsuit seems likely.)  Go to the Equifax Security 2017 website for more information about the breach and the monitoring service.

Beyond that, see the guidance I posted to our blog last Friday. Check your credit reports regularly; you can pull up free reports for Equifax, Experian and TransUnion at annualcreditreport.com. You will have to go to Innovis’ website separately. (Until earlier this week, I had never heard of Innovis.) Consider placing a credit freeze with all four credit bureaus. These freezes can create some hassles, however. An alternative step—though not as effective—is to place a fraud alert with the credit bureaus. Use different passwords for each of your financial accounts. A password manager like Dashlane, which I personally use, can help. Finally, check your financial statements regularly and be quick to challenge any suspicious charges.

Were it not for the breach, this week’s commentary would have focused on the Morningstar ETF Conference, which I attended last week along with AAII Computerized Investing editor Jaclyn McClellan. The conference is oriented toward advisers. While there wasn’t necessarily a “theme” I could point to, the subject of factors was brought up in several of the sessions I attended.

Factors—as those of you who regularly read my weekly musings and/or the AAII Journal know—are characteristics of a stock associated with higher returns. Their popularity has grown within the ETF (exchange-traded fund) industry because they are quantifiable and can be easily be incorporated into an index for a fund to follow. Add in academic research supporting various factors as well as the crowded arena for traditional index (e.g., S&P 500) funds and the appeal of factors for ETF providers should be apparent.

Andrew Ang of BlackRock listed three reasons why a particular factor may work: It realizes potentially higher long-term returns as reward for taking more risk, there are structural impediments to arbitraging it away and it takes advantage of investors’ biases and behaviors. Among the factors Ang mentioned as having long-term viability were momentum, small size and value.

Chris Brightman of Research Affiliates observed the trend of practitioners only publishing research about factors associated with higher returns. He believes this is because of market demands for such research (and a lack of interest for research about what does not work.) Brightman further warned about performance-chasing, meaning targeting factors based on what’s working now.

John West, also of Research Affiliates, cautioned in a different session that over 10-year periods all factors underperform. “You have to go in with a very long time perspective,” West told attendees.

As far as specific factors are concerned, small company size was frequently mentioned. Both Ang and Brightman believe the long-term outperformance of small-cap stocks is compensation for the extra risk investors take by investing in them. A value investing panel that West was a part of said factors work better with small companies. Small-company stocks are more likely to be mispriced due to fewer people investing in them. Quality was another factor frequently mentioned. This factor does not have a consensus as to how to precisely define it, according to Ang. Brightman said his firm does not use quality to due to the lack of academic research defining it. Conversely, Wesley Gray of Alpha Architect uses quality. In discussing deep value stocks, he suggested using quality to “separate the junky from the really junky” companies.

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Highlights from this month's AAII Journal

The Week Ahead

My colleague Wayne Thorp will speak to our Sacramento Chapter about how to use our Model Shadow Stock methodology in an actual portfolio. Thorp will also be speaking at our Investor Conference this November.

Six S&P 500 companies are scheduled to report earnings as we get the first glimpses of third-quarter earnings. Those companies are AutoZone Inc. (AZO), Adobe Systems Inc. (ADBE), Lennar Corp. (LEN) and FedEx Corp. (FDX) on Tuesday; General Mills Inc. (GIS) on Wednesday; and CarMax Inc. (KMX) on Friday.

The Federal Open Market Committee (FOMC) will hold a two-day meeting starting on Tuesday. Interest rates are expected to be left unchanged. The CBOE’s FedWatch tool also shows the futures markets pricing in a 51.3% chance of rates staying unchanged for the remainder of this year. Those odds may, or may not, change following Federal Reserve Chair Janet Yellen’s quarterly press conference on Wednesday. The meeting statement and updated committee member forecasts will be released at 2:00 p.m. ET Wednesday, and the press conference will start at 2:30 p.m.

Elsewhere on the economic calendar, the September housing market index will be released on Monday. Tuesday will feature August housing starts and import and export prices. On Wednesday, August existing home sales will be released. The September Philadelphia Federal Reserve Business Outlook Survey will be released on Thursday. Ending the week, the September Purchasing Managers’ Index (PMI) flash will be released on Friday.

Three Federal Reserve officials will make public appearances: San Francisco president John Williams, Kansas City president Esther George and Dallas president Robert Kaplan will speak on Friday.

The Treasury Department will auction $11 billion of 10-year Treasury inflation-indexed securities (TIPS) on Thursday.

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AAII Sentiment Survey

Optimism surged to its third-highest level of the year in the latest AAII Sentiment Survey. At the same time, pessimism fell to a 17-month low.

Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 12.0 percentage points to 41.3%. Optimism was last higher on January 11, 2017 (43.6%). This is the first time in 29 weeks and only the second time in the past 35 weeks that bullish sentiment is above its historical average of 38.5%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 1.8 percentage points to 36.7%. Neutral sentiment was last higher on July 26, 2017 (41.2%). This is the 20th consecutive week and the 25th time out of the last 26 weeks with a neutral sentiment reading above its historical average of 31.0%.

Bearish sentiment, expectations that stock prices will fall over the next six months, plunged 13.8 percentage points to 22.0%. Pessimism was last lower on April 6, 2016 (21.5%). The drop ends a streak of six consecutive weeks with bearish sentiment above its historical average of 30.5%.

At current levels, bullish sentiment remains close to its historical levels. Pessimism, though low, is also within its typical range.

The big shifts in optimism and pessimism occurred as the Dow Jones industrial average, the S&P 500 and the Nasdaq all set new record highs. The alleviation of fears about the possibility of a larger summer drop in stock prices may be playing a role in this week’s results.

Political drama in Washington remains at the forefront of many individual investors’ minds. Though the August pullback has been reversed, concerns about a larger pullback still exist among some investors. Others, however, are encouraged by continuing economic and earnings growth.

This week’s special question asked AAII members how, if at all, oil prices are affecting their outlook for the stock market in general. Approximately two-thirds of respondents (65%) said oil prices are having minimal or no impact. Many of these respondents simply said “no impact,” while others described the recent increase in oil prices as being temporary. Nearly 21% said oil prices are having a positive impact either by staying low enough to benefit the economy or high enough to help energy stocks. Only 17% view oil prices as having a negative impact.

Here is a sampling of the responses:

  • “I don’t feel that oil prices impact the overall market (just the energy sector).”
  • “I expect oil prices to remain range-bound. So they’re not impacting my outlook.”
  • “It is not impacting my view of the market.”
  • “Low oil prices are good for the economy.”
  • “Oil and gas prices will, in all probability, be a major contributor to inflation.”

This week’s Sentiment Survey results:

Bullish: 41.3%, up 12.0 points
Neutral: 36.7%, up 1.8 points
Bearish: 22%, down 13.8 points

Historical averages:

Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!