Saturday, December 31, 2016

The Final 2016 Dogs Of The Dow Performance And the New 2017 Dow Dog Changes

The 20.5% return for the 2016 Dogs of the Dow exceeded the performance of both the Dow Jones Industrial Average and the S&P 500 Index in 2016. The Dow Dogs returned 20.5% versus 16.4% for the Dow Index and 12.0% for the S&P 500 Index. The best performer of the Dogs was Caterpillar (CAT) up 42.2% with the weakest performer being Pfizer up only 4.5%.


For the coming year, 2017, two of the existing Dow Dogs, Procter & Gamble (PG) and Wal Mart (WMT) will be replaced by Boeing (BA) and Coca-Cola (KO). Boeing has a dividend yield of 3.65% and Coke has a dividend yield of 3.38%.


Most Read Articles From Our Blog In 2016

Below is a list of the most read articles on our firm's blog in 2016. Our generally bullish view on the equity market for 2016 proved rewarding for our clients. We stuck to our bullish call in January when the market was down 8% as noted in the second article link below. When the market began to sell off again into late May, we highlighted our view that equity market headwinds were positioned to subside as noted in the first article link below. Our year-end Investor Letter will be released on Tuesday and will contain additional thoughts on 2016, but more importantly, our outlook for 2017.

To our clients and readers, we wish all of you a Healthy and Prosperous New Year.

Equity Market Headwinds Positioned To Subside - May 20, 2016

Maximum Fear May Be Near - January 15, 2016

Oil And Equity Price Trend Conundrum - August 2, 2016

Is The Value Style Outperformance Sustainable? - March 12, 2016

History Suggests Record Equity Market Highs Do Not Mean Investors Should Sell Stocks - August 11, 2016

Tobin's Q Below 1.0 In Q3 2015 - January 2, 2016

Jobs Were The Missing Link? - August 5, 2016

Value Stock Outperformance May Indicate Stronger Economy Ahead - July 17, 2016

Another Month Of Equity Outflows - September 2, 2016

Bullish Investor Sentiment Lower Than Level Reached In 2009 - May 26, 2016

The FANG Basket Of Stocks Gets Derailed - February 28, 2016


Wednesday, December 28, 2016

Recent Returns Remain Far Below the Longer Term Average

It wasn't until 2013 that the S&P 500 Index broke out 17 year time frame the annualized return (price only) for the S&P 500 Index is approximately 2.59%.



Thursday, December 22, 2016

Has Broadly Improved Sentiment Pushed The Equity Market To An Extreme?

The market's advance since the presidential election has certainly been remarkable. Much of the gain is being attributed to anticipated policies being proposed by a new Trump administration. Obviously none of the proposed policies have been put in place as of yet, but the market is already weighing in with positive expectations. A common thought is whether or not the market has gotten ahead of itself. Given the rapid rise in such a short time period, the market certainly seems to be ahead of itself. However, from a return standpoint, it may not be as can but seen in the below chart. Over the last two years the market's return totals just over 8% and all of the return has come since the election. This makes the average return over the last two years only about 4%.


Much of the positive market sentiment has been driven by a strong improvement in various consumer and business sentiment indicators. Below are a couple of charts showing the spike in a number of sentiment indicators.


Saturday, December 17, 2016

François Trahan Bearish On Stocks In 2017

Whether one is bullish or bearish on equities at any particular time, it is important to read and evaluate opinions that are contrary to ones own. In a recent WealthTrack interview Trahan, voted the #1 portfolio strategist in 10 out of the last 11 years by Institutional Investor Magazine, conducted with Consuelo Mack, François Trahan provides his reasoning for his fairly bearish view on stocks in 2017.

He states the BREXIT inspired pullback was a gift for equity investors. He believes the recent market run up has been predicated on the positive economic data reported throughout the summer months. He does agree the move higher after the election is partly based on anticipated Trump policies. However, he believes much of what a Trump administration is proposing will not work its way into the economy right away, i.e., tax cuts, infrastructure spending, etc. I would say we agree on this as well.


Sunday, December 11, 2016

Investors May Want to Look At Sectors That Worked In The 1980's

Subsequent to the election last month I published a post suggesting the equity market going forward was beginning to resemble the bull market of the 1950's and 1980's, A decade is a long time and market leadership will rotate in and out of sectors based on the business cycle. In that earlier post I noted the potential commonality to the current market compared to those prior decades related to policy decisions coming out of Washington, D.C. In the 1950's the Gross National Product in the U.S. more than double from 1945 to 1960. Government spending in the 1950's was targeted at construction of the interstate highway system, building of schools and an increase in military spending. In the 1980's President Reagan's policies focused on reducing the tax burden on Americans, lowering government regulation and shrinking government itself. President Elect Donald Trump also projects to implement similar policies, i.e., reduce regulation, shrink the government, increase spending on infrastructure and lower taxes. For investors the question to answer is what market segments worked then and might these same sectors outperform early in a Trump administration.


The chart below shows the sector return for the period following the early 1980's recession through 1989. For the entire time period, staples, health care and utilities outperformed with technology being the laggard. I include the Fed Funds target rate for reference since the current Fed is likley of the mind to continue its monetary tightening.


Saturday, December 10, 2016

Emerging Markets, The Dollar and Interest Rates

This morning I published a few tweets and charts on our Twitter site reviewing emerging market equity performance and the impact US Dollar strength has on emerging market equity performance. Additionally, interest rates influence US Dollar movement and rising interest rates tend to result in a stronger Dollar, all else being equal. Below are those tweets.










I frequently provide market relevant tweets throughout the week so feel free to follow our firm on Twitter @HORANCapitalAdv. At the same time, readers may want to follow our broader firm, HORAN on twitter as well @HORAN1948. For over 65 years HORAN has created plans to control health care costs, protect your wealth and insure your life. But the end game for all that we do at HORAN is more than a set of plans. We believe good health and true wealth create a better quality of life for our clients and their families.


Friday, December 09, 2016

Dow Dogs: The Pursuit Of Yield Coming To An End

With the passing of the election last month, expectations in place before the election seem to have been turned on its head. Dire forecast were anticipated if Trump were to somehow pull out a win. Fast forward to a month past election day and current market sentiment is far from what most expected and the equity market is reflecting this in its performance with the S&P 500 Index up 8.4% from the 11/4/2016 Friday close. The positive equity market performance is showing up in sentiment measures as well. Today's release of the University of Michigan's Consumer Sentiment Survey also reflected an improvement in sentiment. Econoday noted,
"Post-election confidence continues to build, lifting consumer sentiment by more than 4 points to a 98.0 level that hits the very outside of the Econoday range and is 1 tenth away from the index's recovery peak hit last year. Consumers specifically cite expectations of new economic policies as the biggest positive."
From a market perspective investors appear to be rotating out of the more defensive and income producing stocks (and bonds) into stocks that will participate in an environment of faster economic growth. Top performing sectors in the S&P 500 Index since the election are, financials (+21.9%), industrials (+13.3%), energy (+13.0%) with the laggards being utilities (0%), staples (+.8%) and REITs (+3.4%). 

This rotation out of the defensive equities is showing up in the lagging performance of the Dow Dogs. The Dogs of the Dow strategy is one where investors select the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Index after the close of business on the last trading day of the year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year. As can be seen in the below table, the average return of the Dow Dogs over the last month equals 1.9% versus 4.7% for the SPDR S&P 500 ETF and 6.6% for the S&P Dow Jones Industrials Index itself.


Whether or not we do or do not view favorably the outcome of the election, as investment managers, we continue to position our clients in sectors and market segments that might outperform under a Trump administration. This led to our positioning of client portfolios into stocks and sectors that might outperform under a faster economic growth environment.


Saturday, December 03, 2016

Small Cap Stocks No Longer Cheap Relative To Large Caps

Subsequent to the election, the equity 'risk on' trade has been most evident in small company stocks with the S&P 600 Small Cap Index returning 13.0% since 11/4 versus a return of 5.4% for the S&P 500 Index.


In fact, small cap stocks have been outperforming large caps since the market pullback in February of this year. Benefiting the return of small cap stocks is the fact, based on their respective P/Es, they were cheaper than large caps on a relative basis as can be seen in the below chart. However, this spike in return over the last four weeks has put the relative valuation of small caps below the average relative value going back to 2004.


Given small caps burst of outperformance over the last four weeks, a period of near term underperformance would not be surprising and would actually be healthy. One factor likely at play though is the anticipation that small cap earnings will begin to accelerate as occurring in the large cap space. The third quarter will market the end of the earnings recession with S&P 500 Q3 2016 earnings expected to be up 4.2% versus Q3 2015. Looking ahead, Thomson Reuters I/B/E/S is estimating earnings growth rates for the S&P 500 Index for Q4 2016 through Q3 2017 at 6.2%, 14.0%, 11.9%, and 9.8% respectively. This improvement in the earnings picture may serve as a floor against an extended equity market pullback.


Saturday, November 26, 2016

Will The FANGs Lag During A Period Of Faster Economic Growth?

In the lead up to and after the November election a significant change in stock leadership has been underway. The better performing sectors are those that will benefit from faster economic growth and a steeper yield curve (like the banks.) Seemingly left behind, or at least underperforming, are the technology stocks as can be seen in the below sector performance chart.


One area of technology that generated out sized returns in 2015 was related to internet and social media companies. The favored group of stocks called the FANGs (Facebook (FB), Amazon.com (AMZN), Netflix (NFLX) and Google/Alphabet (GOOGL) were a beneficiary. The below chart shows the significance of the 2015 FANG returns.


Friday, November 25, 2016

Black Friday For E-Commerce

E-commerce retailers are likely to continue their dominance and be the primary beneficiaries on Black Friday. As the below chart shows, e-commerce sales continue to garner a larger percentage of overall retail sales with traditional brick and mortar retailers stuck in a no growth environment. Further detail on third quarter e-commerce sales can be reviewed in the U.S. Census Bureau's recent e-commerce sales report.


Thursday, November 24, 2016

Individual Investor Sentiment May Be Too Bullish

The American Association of Individual Investors released their Sentiment Survey today and bullish sentiment is reported at 49.9%. This is slightly above the +1 standard deviation level of 48.4%. As can be seen in the below chart, the bullish sentiment level has spiked higher subsequent to the U.S. presidential election from a few weeks ago. Although not shown on the chart, the bull/bear spread widened to +20.1 and is the widest level since November of last year.

Data Source: AAII

Individual investor sentiment measures are contrarian ones and at their extremes frequently coincide with market reversals or pullbacks. Given the strength of the market averages since the election, an equity market pullback or consolidation would not be surprising and actually healthy for a next move higher.


Wednesday, November 23, 2016

An Equity Market Finding Little Upside Resistance

Today the Dow Jones Industrial Average Index closed at another record high of 19,083.18, crossing another 1,000 point interval on Tuesday. It has taken nearly two years for the index to breach this 1,000 point interval after breaking 18,000 in December 2014. The market advance following the election is beginning to sound like a broken record as commentators announce the market's close at a "new all time high" at the end of each trading day.

Emotionally, it feels as though the market is due for a pullback, and for investors in cash, a pullback is being hoped for. A pullback will come just as night follows day; however, the market being a weighing machine as it is, a better investment environment continues to get more priced in based on potential policy changes in Washington.

Turning to the broader S&P 500 Index, the S&P is up 5.6% since the beginning of election week and up 20.4% since the February 11 taper tantrum low. Setting emotions aside and looking at the market technicals, the money flow index and the stochastic indicator appear to indicate the market is near overbought.



Saturday, November 19, 2016

Equity Market Beginning To Resemble Bull Market Of The 1950's And 1980's

In the early days following the presidential election, the equity market seems to be anticipating better economic growth in the years ahead. Knowing the economy is not the market though, investors believe a better economy will translate into stronger corporate profits as well. When the new administration takes office in 2017, Trump's campaign comments indicate the economy is in need of more government spending, specifically on infrastructure and the military. Additionally, a Trump administration has promised tax reform, and specifically tax cuts.

History does not necessarily repeat itself perfectly; however, it does tend to rhyme. The below chart overlays the S&P 500 Index from September, 2013 compared to the bull markets of the 1950's and 1980's. Trump's anticipated policies do have similarities to policies pursued in the 1950's and 1980's and those two decades were periods of a strong bull market.


The decade of the 1950's followed World War II and pent up demand saw the Gross National Product in the U.S. more than double from 1945 to 1960. Government spending in the 1950's was targeted at construction of the interstate highway system, building of schools and an increase in military spending. A Trump administration is indicating a stimulus program would focus on infrastructure and the military.

The decade of the 1980's was know as the Reagan Revolution. A focus of President Reagan's policies was reducing the tax burden on Americans, lowering government regulation and shrinking government itself. During Reagan's years in office, he cut the top tax rate from 70% to 28%. President Elect Donald Trump also projects to implement similar policies as Reagan, i.e., reduce regulation, shrink the government and lower taxes.

The 1950's and 1980's were good decades for equity investors. President Elect Donald Trump is projecting he will pursue policies that look similar to those implemented by presidential administrations of the 50's and 80's. If Trump's policies have a similar impact as those in the 50's and 80's, the coming years could be rewarding for equity investors.


Wednesday, November 16, 2016

Powerful Sector Rotation May Need A Breather

The market action following last week's election has seen powerful rotation among stock market sectors and industries. In my last post I highlighted this movement along with stocks and industries that are benefiting from this rotation and industries that are not benefiting. I noted a potential caution due to the fact the targeted sectors seems to be a consensus trade by investors and the moves may be occurring too quickly. One area benefiting from the rotation is the financial sector at the expense of the technology sector as seen in the below chart.



Sunday, November 13, 2016

Investors Adjusting Investments As A Result Of The Election Outcome

This post is more of a chartfest to feature information I ran across over the weekend from various sources but related to investment topics relevant to potential policy changes under a President-Elect Trump administration. Investors know the equity market reacted favorably to the election outcome last week; however, some market segments did far better than others. Although the night is long, the futures market tonight is indicating a positive open for Monday. The Dow and S&P futures are higher by about .40% to .50% (this is 95 points on the Dow.)


Thursday, November 10, 2016

Toss Aside Your Political Leanings, The Equity Market Is

Tossing aside ones political leanings, the stock and bond market are telegraphing positive results from a Trump presidency as it relates to the economy. I briefly touched on the bond market in yesterday's post and below is another chart of the 10-year Treasury yield-the yield continues to move higher.


Wednesday, November 09, 2016

The Market The Day After The Election: Emotion Versus Fundamentals

In Monday's post I highlighted the importance of separating ones politics from their portfolio. The market's reaction to yesterday's election outcome is a perfect example why this is important. As election results trickled in last night and it became apparent Donald Trump would be the 45th President of the United States, equity futures sold off sharply. The day after election sell offs are not unique. The market sold off 2.4% after the 2012 election and sold off 5.3% after the 2008 election.

The Dow futures were down over 860 points at one point early this morning. In spite of this initial negative reaction, today the Dow Jones Industrial Average closed up 256 points at 18,589 after reaching an intraday all time high of 18,650. At the end of the day, stocks will trade on fundamentals and whether or not one is a Trump supporter, his policy proposals could be very bullish for the economy and stocks. Today's market action is a reflection of this potential positive. Additionally, stock prices follow earnings and it looks highly likely third quarter S&P 500 earnings growth will be positive for the first time since Q1 2015. Q3 2016 earnings growth is tracking to be up 3.9% and 7.5% ex-energy.

The bond market sold off rather sharply in a potential sign investors anticipate a faster pace of economic growth. The 10-year Treasury yield closed at 2.07% and is the highest yield since reaching 2.1% in January of this year.


The market will certainly not move higher in a straight line. Also, the Fed rate decision in December may also create some equity market volatility. However, the election outcome in and of itself may not be bad for the economy and thus could be good for stocks. Separating emotion from fundamentals remains an important characteristic for investors.


Monday, November 07, 2016

Election Day Is Finally Upon Us

In one day the S&P 500 Index recovered six of the nine days of losses incurred over the last two weeks. Today the S&P 500 Index recovered 46.34 points or 2.22% versus the 66.15 point loss (-3.07%) incurred from 10/25 through 11/4. Today's rally did not occur on exceptionally high volume, but the stochastic indicator has turned positive.


Charles Kirk of The Kirk Report made a couple of observations in his strategy note over the weekend.
  • Separate your politics from your portfolio as the combination of the two frequently proves unproductive and unprofitable.
  • If the market continues to decline after the election, it would do something we haven't seen in some time – namely that those selling into weakness have made the correct decision to do so. This market has consistently punished selling into weakness like we've seen of late so, if the market punishes those who haven't hedged, raised cash, and position more defensively, it would be the first sign that a top has been made for the market.
  • Kirk states, "My personal view is that the market will rally significantly no matter who wins the election. The way I think it will continue to go consistently down is in a contested type situation (like a Gore/Bush) which would continue this period of tremendous angst and uncertainty for markets worldwide. I could be wrong as I am often about such matters, but that’s my two cents worth"
Tomorrow is the election and recent market activity is suggesting continued volatility. LPL Research publish a post, What Happens Historically After Elections?, that is a worthwhile read for investors as election day is finally upon us.


Friday, November 04, 2016

Defensive Market Sectors Not So Defensive During Equity Market Pullback

With today's market close the S&P 500 Index has been down for nine consecutive trading days. The index is down 4.2% from the August 15 high, but remains up 4.1% year to date. However, during the pullback from the August high, most of the traditionally defensive sectors have been the worst performing ones. As can been seen in the below bar chart, REITs are down 11.1%, health care is down 10.9%, telecoms down 10.8% and consumer staples are down 5.5%.


Thursday, November 03, 2016

Investors Positioning For The Worst In U.S. Election Outcome


In five days the U.S. election will be behind us, absent a contested outcome. Through yesterday's close, the S&P 500 Index has been down seven consecutive days putting the Index down 4.2% from its August 15 close. This weakness in the markets is now showing up in technical indicators like the CBOE Equity Put/Call ratio. At the close Wednesday, the equity put/call ratio was reported at .99 which is an indication of extreme equity market bearishness from which rallies tend to occur.


Other technical market indicators are also indicating a market that is oversold or at least near oversold. As can be seen in the below market chart, the stochastic and money flow indicators are at levels that have coincided with an oversold market.


And lastly, the percentage of S&P 500 stocks trading above their 50 day moving average stands at 27%.

In summary, investors seem to be positioned for a market that reacts negatively to the election outcome. As the second chart above shows, the market's reaction to the BREXIT vote was certainly negative; however, the sharp decline was fully recovered within a week of the BREXIT results. And from a fundamental perspective, the earnings recession seems to be coming to an end with third quarter earnings now tracking to be up 2.9% with 76% of S&P 500 companies already having reported results. With company fundamentals/earnings turning more favorable and equity shocks like investors are anticipating with the election outcome, the current pullback is more likely to be only temporary as we noted in our BREXIT commentary in June.


Saturday, October 29, 2016

Bonds And Bond-Like Equities Adjusting To Higher Interest Rate Environment

The Federal Reserve meets during the first week of November to decide whether or not to increase interest rates. The probability of a rate hike in November stands at only 8.8% while increasing to 63.3% at the December meeting. With the elevated likelihood of an interest rate hike before year end, income focused investments, both fixed income and bond like equities, are adjusting to this potential outcome.


As can be seen in the above chart, over the last three months, the yield on the 10-year Treasury has increased over 30 basis points while a few selected income focused ETFs are down five percent or more, with REITs (IYR) down 10%.

The same return outcome is occurring with some fixed income investments. As the below chart also shows, bond investments are adjusting to a potentially higher interest rate environment as well. Longer term bonds, as represented by the iShares 20+ Year Treasury ETF (TLT), have fared worse than bonds of a shorter maturity and is down over 7%.


A Fed rate increase before year end is not a certainty; however, with market rates adjusting to a higher level, bond like equities and longer term bonds remain under pressure.


Thursday, October 27, 2016

U.S. Government Has A Spending Problem

As of the end of the second quarter the U.S. government's budget deficit is once again widening and stands at $664 billion compared to $543 billion at the end of 2015. As can be seen in the below chart, government outlays as a percentage of GDP equals 22.4% and above the long run average of 20.3%. Additionally, government revenue as a percentage of GDP equals 18.8% versus the long run average of 17.7%. The gap is real but the percentages are elevated due to the continued weak growth of the economy in this recent expansion and hence the below trend GDP level.

In absolute dollar terms, the deficit has widened in spite of record tax receipts/revenue collected by the government. The below chart shows revenue is up 30% since just before the the start of the last recession. Government receipts have increased from $2.669 trillion to $3.472 trillion. At the same time, government expenses have increased at a far faster pace, up 39% over the same time period to $4.137 trillion from $2.979 trillion.


A significant issue with government expenditures is the high level of non-discretionary items. Additionally, net interest expense stands at $248 billion, 6% of the budget. If the recent move in interest rates is any indication of future interest expense on the government's debt, the budget deficit will likely continue to widen without implementation of policies that are pro-economic growth. Since July 6, the yield on the 10-year Treasury has increased 53 basis points from 1.32% to 1.85%. As new debt is issued to fund the deficit, these higher interest rates will be problematic for the government's budget.


Aside from interest on the government debt, explosive growth in entitlement spending will need to be addressed in order to bring discipline to the government's budget as well. Rhetoric that the middle class will not be impacted by tax hikes is just that, rhetoric. It was recently announced that wages subject to the social security tax will increase from $118,500 this year to $127,200 in 2017, a 7.3% increase and thus directly impacting the middle class tax payer. There are no easy solutions to addressing the government's budget deficit, but addressing this sooner versus later can ease any potential pain.


Monday, October 17, 2016

Fall 2016 Investor Letter: Time In The Market

In our recent published Fall 2016 Investor Letter, our commentary covers recent market related events, U.S. earnings, interest rates and the pending election. Emotions tend to run high during these times creating an environment that can drive investors to reduce their stock market exposure. The newsletter discusses the consequences these decisions can have on long-term returns. 

In our Summer 2016 Investor Letter, we highlighted our positive view on U.S. equities, supported by an anticipated resumption in earnings growth for the second half of 2016 and into 2017. Although analysts expect companies in the S&P 500 Index to report a slight drop in quarterly earnings for the third quarter, we believe reported earnings will turn positive in the quarter and discuss this in the Investor Letter.




For additional insight into our views for the market and economy, see our Investor Letter accessible at the below link.


Sunday, October 16, 2016

Slow Economic Growth Has Led To Weak Job Growth

One factor that has turned into 'normal' for this economic recovery is its slow rate of growth. Out of the eleven recoveries since 1949, the current one is the slowest, barely averaging above 2%.


This slow rate of growth has left a gap in potential economic output of nearly $3 billion. In percentage terms the economy's slow rate of growth has expanded 16% below its long run potential.


This missed potential output has resulted in a weak labor market where individuals have been unable to find jobs, many simply dropping out of the labor force. The increase in those not in the labor force has resulted in a decline in the participation rate. The participation rate refers to the number of individuals over the age of sixteen who are either employed or are actively looking for work compared to the overall civilian population. The latest participation rate equals 62.8%. Prior to the financial crisis, the March 2008 participation rate equaled 66.1%. This fall in the participation rate has created a gap of 8 million people that are not employed. A result of these fewer employed individuals is an increase in those not in labor force as can be seen in the below chart.


Since March 2008 the rate of growth in the 'not in labor force' category has steepened with total employment growing at a slower pace.


The factors contributing to this drop in the participation rate is not completely clear, but the monthly Bureau of Labor Statistics Job Openings and Labor Turnover report shows job openings are at their highest level in fifteen years, 5.4 million job openings. A part of the drop in the participation rate is likely attributable to a mismatch between the available jobs and the skills of job seekers.


This slower rate of GDP growth puts the Fed in a predicament as to the timing of the next Fed interest rate increase if job creation is of concern to the committee. Janet Yellen stated after the September Fed meeting that she believes the job market is returning to health due to an uptick in the participation rate. However, in a recent Fortune article, Neil Dutta, Chief Economist with Renaissance Macro Research points out, "if you look at the actual flow data showing the number of people each month entering and exiting the labor force, the rate at which workers are entering the labor force is actually lower today than at any point over the last two years." 

Source: Fortune

With the probability of a rate hike in November at less than 10% and odds just under 70% in December, the market seems to be expecting a rate increase before the end of the year. Although a 25 basis point rate increase from this low level of interest rates likely does not cause an economic shock, the current slow pace of economic growth is a factor that needs to be considered.

A quickening pace of GDP growth does not seem on the horizon either. The Atlanta Federal Reserve uses data to create a more current estimate of GDP growth called GDPNow and last week they lowered their third quarter forecast down to 1.9% from a prior estimate of 2.1%.


In conclusion, with the economy seeming to continue to grow at only a snails pace and a labor market that is really not overheating, a Fed rate increase before year end would likely not contribute to improve the pace of hiring.


Wednesday, October 12, 2016

Positive Equity Markets In The Year After The Presidential Election

Absent an election year, equity markets generally trend higher until the seasonally weak September/October months. However, during an election year, equity market weakness tends to occur during the summer months and subside as the November election draws near. Historically, markets then rally into year-end. The market has followed this pattern so far this election year. As the below chart shows, when reviewing each November election dating back to 1988, the S&P 500 Index’s performance for the following 1-year is positive 7 out of 8 times. The only negative period was during the bursting of the tech bubble in 2001.


This election year certainly seems to be a very polarizing one. The newly elected President will need to tackle many policy issues: foreign policy, foreign trade, U.S. deficits, student loans, health care, global terrorism and defense, immigration, individual and corporate tax reform, just to name a few issues. We would, however, reiterate what we wrote in our Spring 2016 Investor Letter. We believe a President can exert significant influence over a specific industry (the Obama presidency and the impact on health care and coal), but, he/she has limited influence on the overall direction of the broader market. So as election day draws closer, the uncertainty of the outcome will clear; thus, potentially, paving the way for higher equity prices into next year.


Sunday, October 09, 2016

Investors Rotating Out Of Income Generating Equities

Since mid August the S&P 500 Index was down approximately 3% to mid September, but has recovered about 1.3% to Friday's close. The market seems to be having difficulty finding direction, trading mostly sideways since mid July, as can be seen in the below chart that includes the transport index as well.


As I noted in a post in early September, transports began outperforming the S&P 500 Index at that time after trailing the broader market for most of the second quarter. When the transports begin to lag the broader market there is some belief this is potentially a precursor to a weakening economy that leads to a decline in the S&P 500 Index. As the above chart shows though, transports appear to be in decent shape, potentially pulling the S&P 500 up with it on improving economic fundamentals.

A part of what seems to be occurring in the broader market is a rotation out of the income and defensive sectors. In looking at sector returns since the beginning of the year (blue bars) and returns since the end of June (yellow bars), the weakest part of the market since the end of the second quarter has been health care, staples, REITs and utilities. The top performing sectors since June are the more economically sensitive ones, technology, financials, energy and industrials. I have discussed in earlier posts about the likelihood of the coming end of the earnings recession in Q3. Aggregate 'as reported earnings' for the S&P have already increased for three consecutive quarters.


This rotation out of the defensive/income sectors is also showing up in the downtrend in the advance decline lines for the defensive/income sectors.


A part of the flow out of dividend yielding stocks is the anticipation of a Fed rate hike before year-end. The 10-year Treasury yield has already moved higher from a yield of 1.32% in July to 1.73% at Friday's close. Higher interest rates tend to result in the price of dividend yielding stocks, bond like equities as some call them in this low rate environment, to fall. This has been the case with the bottom performing income oriented sectors. The price decline has been relatively quick as can be seen in the below chart of the utility sector.



In conclusion, the S&P 500 Index remains just 1.7% off its August high in spite of quite a bit of pessimism. The AAII bullish sentiment remains at a low level, 28.79%, and fund flows continue to exit equities with funds suffering their worst weekly out flows of the year, yet the market remains near a high. From a technical perspective, Charles Kirk of The Kirk Report always cuts through the noise to provide good technical detail on the markets and stocks. In his report this week he provided the below chart noting:
"Overall, the probabilities still favor a bullish breakout to higher highs. Why is that? The combination of both the short and long-term bullish plays that remain in motion. The longer-term double bottom breakout play targeting S&P 2365 remains in play. While price has seemingly stalled out over the past seven weeks, there has not been any significant roll back either other than the -3% throwback retest last month that successfully tested and held support. All that is needed now is to take out the August highs and start acquiring the numerous bullish target objectives."

All else being equal, I believe the earnings recession should end this quarter (energy is a wild card and key) and the sideways market action is partly due to sector rotation. As more certainty is established about the election outcome and the Fed rate decision, equities could see a move higher into year end.


Saturday, October 08, 2016

Why We Sold Tyson Foods In September

At the end of September our research led us to sell Tyson Foods (TSN) common stock in our client accounts. Our firm relies heavily on fundamental research in our stock research in order to uncover buy and sell opportunities for our clients' portfolios. What led us to our sell decision was not the direct reason TSN was down nearly 9% on Friday, but an indirect one.

As background, our firm added TSN to client accounts in May of 2015 following the stock's decline as a result of bird flu showing up in poultry in Arkansas where Tyson has poultry operations. In short, we felt the bird flu issue was a temporary one and that TSN would recover from this issue. Additionally, we expected TSN to benefit from its acquisition of Hillshire Foods that had closed in August 2014. The acquisition benefits materialized, the bird flu situation passed, and TSN's stock price recovered nicely. After our initial decision to purchase TSN on May 14, 2015 at $41.76, we trimmed the holding on May 19, 2016 at $64.88, a 55% gain after one year. One of our risk control disciplines takes into account position size and this was one of the reasons for trimming the holding in May. We sold the remaining TSN position on September 30 at a price of $74.52 and the sell was made for fundamental reasons.

Tyson's stock is not necessarily trading at an extended valuation, 18 times earnings at the time of our sell, when compared to the overall market. Additionally, the earnings growth rate for Tyson in the later part of 2015 and through September of 2016 has been strong. As the below snapshot of earnings shows, YOY growth ranged from 49.4% to 51.3% in Q3 2016. Fourth quarter (9/30/2016) is expected to see YOY growth of 33.5%.


Beginning in the December quarter though, YOY earnings growth is expected to decline to single digits, 7.1%. Further, without share buybacks, the YOY earnings growth rate would equal only 2.6%. Therein lies our issue with the stock. Tyson is a good company, but the company's stock price seems to have gotten ahead of earnings growth fundamentals at least near term. One factor that tends to serve as a headwind for stocks is when the growth rate of earnings is slowing over time, especially after being strong for an extended period of time historically. In this slowing earnings growth environment, often times a stock's valuation will adjust to account for the slowing earnings growth rate. This adjustment can occur either over time by trading sideways or can adjust in price be some decline in the stock's price.

This leads me back to the 9% decline in TSN's stock price on Friday. The decline was in response to a research report released by Pivotal Research Group. In the report Pivotal indicated there might be price fixing issues related to broiler chickens. The report's conclusion is related to a class action complaint filed on September 2nd, Maplevale Farms, Inc. v. Koch Foods, Inc. et al, According to Pivotal, "The complaint alleges that Tyson, together with Koch Foods and multiple other players in the broiler chicken business, systematically colluded to reduce production of broilers since about 2008. The mechanism for collusion is not a shady meeting in a hotel room, as was once done by players in the lysine market. Rather, the complaint alleges supply collusion occurred through nonpublic data exchange; detailed industry reports compiled on a daily or weekly basis by Agri Stats, Inc., a subsidiary of Eli Lilly and Co., and then sold back to industry participants."

In conclusion, all else being equal, at the time of our last sell of TSN, we believed the company's stock valuation needed to decline to a mid to low double digit P/E multiple given the slowing earnings growth rate. With Pivotal highlighting the recent class action lawsuit, this to could have a negative impact on TSN margins and future earnings growth. As a result TSN's stock price has and is adjusting to a P/E multiple that is more in line with the anticipated growth rate of TSN earnings. For investors, when earnings growth of a company slows from over a 40% growth rate to single digits, a stock's price will often adjust downward to account for this slowdown. On top of this, when secondary news like the above noted class action lawsuit comes out, a stock priced for perfection can decline sharply, as was the case for TSN Friday.


Friday, October 07, 2016

Inspite Of Decline In Buybacks, Aggregate 'As Reported Earnings' Continue To Increase

Last week S&P Dow Jones Indices reported preliminary aggregate data on buybacks, dividends and earnings for the quarter ending June 30, 2016. Of note in the second quarter is buybacks declined 21% versus Q1 2016 and down 3.1% versus Q2 2015. Importantly, as reported earnings increased for the third consecutive quarter increasing to $201.79 billion versus $189.37 billion in Q1 2016. Dividends of $98.3 billion represented a 4.1% increase versus Q2 2015. Year over year dividend growth has remained positive since June 2010, although growth has slowed to a mid single digit growth rate.

Data source: S&P Dow Jones Indices

As Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices notes in the report,
  • Cash reserves also set a new record for the second consecutive quarter, as S&P 500 Industrial (Old), which consists of the S&P 500 less Financials, Transportations and Utilities, available cash and equivalent now stands at $1.374 trillion, up 2.0% from the prior record of $1.348 trillion. The current cash level is 86 weeks of expected 2016 operating income (the same as was posted for Q1 2016), giving corporations leeway in their expenditures.
  • “Shareholder returns continue to be strong, even as the quarter ticked down from last quarter’s record, Cash has increased to a record, as low-cost financing globally remains plentiful."
  • "The rate of dividend increases continues to slow across sector lines, as income investors remain limited in their alternatives. Base buyback expenditures, those used to negate stock options, may need to increase in Q3 2016 to compensate for higher share prices. Discretionary buybacks, used to reduce share count and increase EPS, remain the main unknown.”


Sunday, October 02, 2016

More Signs Of An Earnings Recovery Unfolding

As I have noted in recent posts, an earnings recovery seems to be unfolding. Increasingly, more data continues to point to this earnings recovery over the course of the next twelve months. On Friday, the Economic Cycle Research Institute released data on its proprietary Weekly Leading Index. A variation of this same index is the Leading Growth Index (WLIg). As the following chart shows, the WLIg turned positive in March. Importantly, earnings growth tends to follow changes in the WLIg and recent positive equity market returns may be anticipating an improvement in both the economy and earnings.


Two variables that led to the earnings headwinds in 2015 were the strong U.S. Dollar and the contraction in oil prices, both of which had a negative impact on a number of sectors in the economy. Brent Crude equaled $36 per barrel at the end of 2015 and closed in September at $46 per barrel. Oil prices are likely to remain volatile; however, OPEC’s announcement at the end of September of a production cap (cut) provides some desire by OPEC to see some balance in the supply and demand for oil. This potential balance will be favorable for companies exposed to the energy sector of the economy. As a caution though, in the early 1980’s, OPEX cut supply and then saw oil prices fall 40% as other producers increased supply in order to capture market share. In fact, a similar dynamic could play out this time as the Baker Hughes rig count has increased from 408 in May to 481 in August.


Sunday, September 25, 2016

The Risk Of Dismissing The Data: The TED Spread And Baltic Dry Index

No single variable or statistic provides clear insight into the future direction of the economy or stock market. When a data point does not fit ones narrative though, justification to eliminate it seems to be gaining among some strategists. Recently, the market has seen a fairly significant spike in LIBOR and a resultant increase in the TED Spread, i.e., 3-month LIBOR minus 3-month Treasury.




Thursday, September 22, 2016

Sentiment: Investors Not Believing The Rally

This morning the American Association of Individual Investors released their Sentiment Survey showing a 3.1 percentage point decline in bullish sentiment to 24.8%. The bullish sentiment reading reported by individual investors remains below the -1 standard deviation level of the sentiment measure which is 28.3%.The 8-period moving average of the bullish reading declined as well to 29.6%. 

A vast majority of the decline in bullish sentiment showed up in bearish sentiment (+2.4 percentage point increase) with a net impact of widening the bull/bear spread to -13.5. This is the widest the bull/bear spread has been since late May when the spread was -14.8. Since that point in May the S&P 500 Index is up 5.6% on a price only basis. As individual investors continue to doubt the markets this year, they continue to move higher nonetheless.



Monday, September 19, 2016

Heightened Market Volatility Would Favor Low Volatility Strategy, But It Looks Expensive

A little more than a year ago we wrote about the outperformance of the low volatility strategy versus a more risk on/high beta strategy. At that time it was noted low volatility could persist; however, if the broader market reached new highs, the high beta strategy would likely outperform low volatility. This has essentially played out and as the calendar turned to 2016 the early year market pullback saw the high beta strategy succumb to significant selling pressure and was down 20% into the February low, almost twice the broader market's beginning of year decline. Once the market began recovering from the February low though, high beta has outperformed the low volatility strategy, 25% versus 9%, respectively.



Sunday, September 11, 2016

The Dogs Of The Dow And The Risk With Exchange Traded Notes

Three quarters through the year, the Dogs of the Dow strategy continues to be a winning one, outpacing the Dow Jones Industrial Average and the S&P 500 Index by nearly three times. The average return of the 2016 Dogs of the Dow equals 16% versus the Dow Index return of 5.7% as of Friday's close. As noted in earlier posts, the Dogs of the Dow strategy is one where investors select the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Index (DJIA) after the close of business on the last trading day of the year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year.


With the popularity of indexing, some investors have pursued the Dow Dogs strategy via an exchange traded note, the ELEMENTS "Dogs of the Dow" Linked Note (DOD). The return of this note has varied greatly from the performance of the Dogs of the Dow themselves. There are peculiarities with these types of exchange traded products investors should be aware of. More detail on the risk of exchange traded notes can be read here. Two important ones are the fact these investments are essentially bonds of the sponsor of the exchange traded note. In the case of DOD, the issuer is Deutsche Bank AG and an investor in DOD has unsecured credit exposure to Deutsche Bank AG. Secondly, the return on these notes are 'based' on some underlying index or basket of investments. In the case of DOD the ETN's return is based on the Dow Jones Select 10 Total Return Index. Because the issuer is not required to issue more shares of the ETN, the price of the ETN can diverge from the value of the underlying Index and in some cases the divergence is significant. This has occurred with DOD as can be seen in the below chart.



Year to date through early June DOD was up nearly 60% while the underlying Dow Jones Select 10 Index was up only 11.3%. As is typically the case, the large premium at which DOD traded quickly narrowed to the actual return of the underlying index.

Lastly, in this low interest rate environment, investors have a heightened focus on income generating equities. From a total return perspective though, the Dogs of the Dow strategy has had mixed results from year to year.