Sunday, February 28, 2016

The FANG Basket Of Stocks Gets Derailed

Investors not owning the basket of stocks know as the FANGs (Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOGL aka Alphabet)) in 2015 likely trailed the return of the broader market. The average return of the FANGs in 2015 equalled 83% versus the S&P 500 Index return of 1.4%.


With the emotional propensity for investors to buy what feels good, if they purchased the FANG basket of stocks near year end, the return on these stocks has trailed the overall market return: -12.6% versus -6.4% for the S&P 500 Index since December 4, 2015.


The weakest link in this basket has been Netflix which has declined 27.6% since the December peak of the FANG basket. The best performing FANG stock since their December top has been Facebook returning 1.6% and outperforming the S&P 500 Index return of -6.9%. The S&P 500 Index has outperformed the other three FANGs, Alphabet, Amazon and Netflix.



Disclosure: Long GOOGL and GOOG


Saturday, February 27, 2016

Are Emerging Markets The Trade Of The Decade?

In recent days, more strategists are indicating the emerging market asset class is providing investors with a 'trade of the decade" opportunity. The most recent is Robert Arnott and Christopher Brightman of Research Affiliates when they note in their February All Asset report,
"Many investors mistake a bear market for diminished prospective returns. From the rear-view mirror, the bear market in emerging markets has been painful. When we look out of the windshield, however, these very asset classes offer the highest potential returns (as of 12/31/2015 their 10-year expected return is 7.9%) available to today’s opportunistic investor. So, the exodus from emerging markets is a wonderful opportunity – and quite possibly the trade of a decade – for the long-term investor."
Certainly, the below chart shows the underperformance of the MSCI Emerging Markets Index versus the S&P 500 Index.


For investors interested in increasing emerging market exposure, they will want to evaluate the potential impact of further US Dollar strength due to the negative impact a strong Dollar has on emerging market performance.


Historically, Dollar strengthening moves have trended in a 7-year cycle. As the below chart shows, the most recent Dollar move has been running for about four and a half years. If the seven year pattern holds, continued weakness in emerging market performance may persist. Admittedly, a lot of the Dollar strengthening move has occurred; however, with the Fed interested in continuing to normalize interest rates, higher U.S. rates would likely provide some tailwind for additional Dollar strength.


Bearish Sentiment And Positive Uptick In Economic Reports May Translate To Higher Equity Prices

Evident from the below chart of the S&P 500 Index and the Dow Jones Industrial Average, the start to 2016 has been a difficult one for investors. January saw a sharp decline in the equity markets; however, the month of February is working to repair the January damage.


We noted in a post at the end of the third weak of January, Sentiment Supportive Of Further Equity Gains, that sentiment data seemed overly bearish and the market could recover. Certainly this has been the case, yet institutional and investor sentiment continues to tilt more bearish than bullish.

The chart below displays the NAAIM Exposure Index. The NAAIM Exposure Index consist of a weekly survey of NAAIM member firms who are active money managers and provide a number which represents their overall equity exposure at the market close on a specific day of the week, currently Wednesday. Responses are tallied and averaged to provide the average long (or short) position or all NAAIM managers, as a group. This week's data for the NAAIM Index continues to indicate active managers remain cautious on the equity market and is near levels notable for oversold markets.


Additionally, although individual investors are slightly more bullish based on the Sentiment Survey from the American Association of Individual Investors, bullish sentiment remains at a low level. Last week's AAII report saw investor bullish sentiment increase to 31.19%, the first reading over thirty since the end of November last year. In order to smooth out the week to week volatility in the sentiment reading, we look at the 8-period moving average. As the white line in the below sentiment chart shows, this average continues to track at an extreme level, even lower than that reached at the bottom of the financial crisis in March of 2009.


One data point needing to see improvement is that associated with the consumer and a reasonably strong spending and income report was delivered for January. It appears the benefit consumers receive through low energy prices are beginning to translate into increased spending.



Econoday's commentary on the report:
"Personal income jumped 0.5 percent in January as did consumer spending, both readings higher than expected. Details are solidly positive with components on the income side led by wages & salaries, up a very strong 0.6 percent for the third large gain of the last four months. And year-on-year rates are climbing again with total income up 4.3 percent and with wages & salaries at 4.5 percent, which are far from torrid but the direction is definitely favorable. And consumers didn't draw from savings on their January shopping spree, with the savings rate unchanged at a very solid 5.2 percent. Components on the spending side are led by durable goods which jumped 1.2 percent and reflect strong vehicle sales in the month. Spending on services rose a monthly 0.6 percent. Year-on-year, spending is up 4.2 percent. Again, this isn't great but it does point to a surprisingly strong start to the first quarter which looks to double or triple the fourth-quarter's annualized growth rate of 1.0 percent."
And finally, the improvement in equity returns in February is occurring in some of the more economically sensitive sectors. The below chart shows materials are up 8.5% this month and industrials are higher by 4.9%. At a minimum the market may be beginning to factor in the easier earnings comparisons firms will face as they lap the headwinds from the strong US Dollar and the contraction in energy prices.


One thing we know about the market is it does not move higher in a straight line. The strong recovery over the last two weeks may see some consolidation of these recent gains. However, some glimmer of hope is beginning to surface in a number of economic reports, a revised higher GDP number, an improvement in industrial production and improvement seen in the durable goods report. Everything is not roses as weakness was seen in Markit's Manufacturing PMI and the ISM Manufacturing Index. Investors continue to deal with mixed economic reports, but a number of the reports are beginning to turn positive. If one believes stock prices follow earnings, improvement in earnings reports would be a welcomed outcome. 


Thursday, February 18, 2016

E-Commerce Sales Continue At Double Digit Growth Rate

Yesterday, the U.S. Census Bureau released fourth quarter 2015 e-commerce sales data. The report confirmed the fact individuals are increasingly turning to the internet for their retail purchases. The orange line in the below chart shows as of the end of Q4 2015, e-commerce sales as a percentage of total sales increased to 8.6%. Also notable in the below chart is the blue line representing the YOY change in e-commerce sales: e-commerce sales grew nearly 15% in the fourth quarter last year. The increase in internet retail has come at the expense of brick and mortar retailers as evidenced by the near zero percentage growth rate in overall retail sales less motor vehicles and e-commerce sales (green line).




Saturday, February 13, 2016

Increased Market Volatility Resulting In High Quality Stock Outperformance

Commensurate with the increase in the market's volatility that began late last year, high quality stock outperformance has accelerated this year. As volatility increases it is common for investors to seek the safety of higher quality equity holdings. The below chart displays the ratio of S&P's high quality index to the low quality index.The S&P Quality Ranking System measures growth and stability of earnings and recorded dividends within a single rank.
  • S&P Low Quality Rankings are designed for exposure to constituents of the S&P 500 identified as low quality stocks, i.e., stocks with Quality Rankings of B and below.
  • S&P High Quality Rankings are designed for exposure to constituents of the S&P 500 identified as high quality stocks, i.e., stocks with Quality Rankings of A- and above.

One factor contributing to the underperformance of the low quality index is the large 29% weighting in financials versus 5% in the high quality index. As the last chart below shows, financials have taken it on the chin so far this year.









Friday, February 12, 2016

Ex-Energy Forward Earnings Expectations Look Pretty Good

The list of headwinds facing the equity market seems to be growing longer every day. However, the top concern is the question of whether the economy is headed for a recession or not. In several prior posts, we have noted our view is a recession is not imminent. Certainly slow GDP growth continues to be the constant in this long recovery. Much of the market volatility though seems centered around the energy and material sectors.

At the end of 2014 a barrel of oil was trading for $53.27 and closed today at $27.64. Demand for oil has not been the issue, it has been the continued growth in supply. The low energy prices have resulted in large capital expenditure cuts in the sector and this has spilled over into the industrial sector, especially those firms selling into the energy space either directly or indirectly. The earnings results for energy firms and those firms impacted by the energy contraction have dominated the headlines. In evaluating the fundamental health of companies outside of energy, we believe it is worthwhile noting expected 12-month forward earnings growth, ex energy, is anticipated to be just over 13%. We do believe this is a little optimistic; however, high single digit EPS growth is achievable looking out 12-months.

From The Blog of HORAN Capital Advisors

On an operating earnings basis the energy sector is expected to contribute a negative $7.71 to overall S&P 500 Index reported operating earnings in 2015. In 2016, the energy sector is expected to contribute a positive $7.45 to overall S&P operating earnings. Again, we think the energy earnings contribution is on the high side and is one reason we expect 2016 S&P 500 earnings growth around the high signal digits.

Thomson Reuters excellent weekly earnings report from the end of last week included earnings growth expectations for 2016 broken down by quarter. Evident in the below table is the weakness expected for earnings through Q1 2016. For the last three quarters of 2016, earnings growth improves in each quarter. Some of this improvement will be the result of lessening currency headwinds for multinational firms due to the strong US Dollar. At the end of 2014 the US Dollar/Euro exchange rate was $1.20. Through the end of November of 2015, the Dollar strengthened to $1.05 to the Euro. Subsequent to the end of November, the Dollar has been weakening and traded near $1.13 today. This weaker Dollar will lessen the currency impact for many multinational companies.

From The Blog of HORAN Capital Advisors

Much of the bombardment of negative headlines has weighed on investor sentiment. Today the American Association of Individual Investors reported an 8.31 percentage point drop to 19.2% for the bullish sentiment survey reading. These bullish investors flipped to the bearish side with bearish sentiment increasing 14 percentage points to 48.7%. The net impact is the bull/bear spread is a wide -29.5%, the widest level since October 2008. These sentiment readings are most predictive at their extremes and the AAII Sentiment Survey is a contrarian indicator.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Of course there are other issues impacting the market outside of energy and exchange rates, like always seems to be the case. However, we believe the energy headwinds, and the consequent impact on high yield credit and on bank loans, will have a much smaller impact as compared to the real estate issues in 2008/2009. 


Sunday, February 07, 2016

Weak Investor Sentiment Leading To Negative Fund Flows

The weak equity returns experienced by the markets since the beginning of the year have resulted in a low level of bullish investor sentiment. The Dow Jones Industrial Average Index and the S&P 500 Index are down on a year to date basis 7% and 8%, respectively. The Nasdaq Composite Index has fared even worse and is down 12.9% this year. The lack of positive equity momentum and weak bullish sentiment have led to investors reducing exposure to both stocks and bonds as evidenced by recent mutual fund flow data.

From The Blog of HORAN Capital Advisors

The above chart incorporates data through the end of last year. Below is a table from ICI showing weekly outflows have continued into 2016.

From The Blog of HORAN Capital Advisors
Source: ICI

In mid-January bullish investor sentiment, as reported by the American Association of Individual Investors, came in at 17.90%. The last time bullish sentiment was reported at this low of a level was in April 2005. Subsequent to the mid-January sentiment report, individual investor sentiment began to improve until falling two percentage points to 27.55% last week.

From The Blog of HORAN Capital Advisors
Source: AAII

As we noted earlier this month, we do not believe the U.S. economy is headed for a recession. Given all the pessimistic talk of late though, one would think we are in a recession now. Because sentiment is a contrarian indicator, and given the negative fund flow data, maybe the end of this pullback is nearer the end than investors are anticipating.


Saturday, February 06, 2016

The Dogs Catch A Bid

The Dogs of the Dow theory suggests 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. Below is the 2016 Dogs of the Dow.

As the below table shows, year to date through Friday's close, the Dow dogs have outperformed the Dow Jones Industrial Index, -2.5% versus -7.0% . As the below table also shows, the average yield for the 2016 Dogs of the Dow of 3.97% remains higher than the overall DJIA yield of 2.96%. In this market environment where the market is struggling to gain any traction, the income yield on the stocks seems to have enticed investors to purchase, or at least hold these higher yielding stocks.

From The Blog of HORAN Capital Advisors

One aspect of market returns in 2015 was the narrow nature of stock participation. As we noted in our Winter 2016 Investor Letter, the FANG stocks were up over 60% last year on a cap weighted basis. So far in 2016, the average return of the FANG stocks is -12%. The outperformance of the Dow Dogs at the start of 2016 may be a larger indicator of investor interest in more value oriented equities. As the below chart details, growth style equities have been on a strong outperformance trend versus value since the end of the financial crisis. The brief return to value outperformance has occurred during short stints since 2009, but has been unable to gain traction on a longer term basis. Maybe this early trend in 2016 will be the theme for the remainder of the year. We discussed the growth value difference in our post at the end of last year, 2015 Was A Year For Growth Stocks And Only A Handful Were Needed.

From The Blog of HORAN Capital Advisors



Monday, February 01, 2016

Economic Weakness Centered In Energy/Materials Sector: Not A Recession Yet

A significant issue facing investors is determining whether the world is entering into a global recession. Certainly, economic activity in emerging markets has been challenged due in part to the strength of the U.S. Dollar. Global economies are also dealing with the collapse of energy prices and the negative impact energy weakness is having on the broader industrial sectors as energy capital expenditure cuts ripple through the economy. As noted in our post yesterday, historically, energy prices and equities have a positive correlation, that is, they move in the same direction. Intuitively this makes sense as a stronger global economic environment leads to a higher demand for energy resources. Since late 2013 this correlation broke down and energy prices began to move in the opposite direction of stocks. When January 2016 rolled around though, the correlation between oil and stocks once again turned positive.

Absent ongoing excess supply, weaker energy prices have been one signal the economy is slowing, however, is something different occurring today that is causing this disconnect? We think so and it has to do with too much supply and not a reduction in demand. So back to the recession question. Below are a few economic variables which we believe tilt towards a growing economy, albeit a slow growth one.

Indicators exhibiting a positive trend:
  • Jobless Claims
  • Consumer Confidence
  • Existing Home Sales
  • Retail Sales
  • Interest Rate Spread (the TED spread)
The three indicators showing weakness:
  • Durable Goods Order
  • Industrial Production
  • ISM Purchasing Managers Index (Manufactures Survey)
    Jobless Claims
    • Continued improvement is seen in the 4-week moving average of initial jobless claims with the latest reading reported at 283,000. Additionally, the Job Opening Level (red line) continues to move higher and is far above the level prior to the last recession.
    From The Blog of HORAN Capital Advisors

    Existing Home Sales
    • In December the National Association of Realtors reported a 14.7% seasonally adjusted annual rate of growth in existing home sales. This puts the number of units at 5.46 million for December versus the annual rate of 4.76 million in November. The median home price rose 7.6% in December 2015 versus the same period in 2014. One factor contributing to sale price increases is the low level of homes for sale. Potential headwinds to home sales in 2016 is potentially higher mortgage rates as the Fed continues to move interest rates higher and a weak home market in areas negatively impacted by weak energy prices. 
    From The Blog of HORAN Capital Advisors

    Retail Sales and Consumer Confidence
    • For the month of December 2015, retail sales did decline .10% versus November. For the fourth quarter of last year, retail sales were up 1.8% versus the same time period in 2014. Included in the below chart with retail sales is consumer confidence and the trend in confidence continues its upward trajectory. With the decline in energy prices and a strong confidence level, retail spending is likely to maintain its upward trend. The economy is unlikely to dip into recession when consumer confidence continues to exhibit strength.

    From The Blog of HORAN Capital Advisors

    TED Spread
    • The TED Spread is the difference between the yield for 3-mo Treasury Bills and 3-mo Libor. The spread represents the premium investors require to lend money to a bank rather than to the U.S. Treasury. The spread has remained below 50 basis points since early 2012. The spread spiked above 50 in January 2012 on the back of the gridlock in Washington D.C. surrounding the debt ceiling debate and the eurozone crisis that involved Greece. The current spread is elevated and worth watching; however, readings below 50 are indicative of an environment where credit risk among counterparties is not increasing.

    From The Blog of HORAN Capital Advisors

    Durable Goods
    • As reported by the U.S. Census Bureau, new orders for manufactured durable goods in December declined 5.1%.
    • The decrease, down four of the last five months, followed a 0.5 percent November decrease.
    • Excluding transportation, new orders decreased 1.2%.
    • Excluding defense, new orders decreased 2.9%. Transportation equipment, also down four of the last five months, led the decrease, down 12.4%.

    From The Blog of HORAN Capital Advisors

    Industrial Production and ISM Purchasing Managers Index
    • In December Industrial Production declined .4% and was centered in weakness in utilities and mining. The weakness in the utilities sector is the direct result of a warmer winter across parts of the U.S. Weakness in mining reflected lower commodity prices and contraction in energy extraction,
    • Weakness in the ISM Manufacturing Index was centered in the decline in employment by 2.1 points. The one positive from the report was the increase in new orders which came in at 51.5.

    From The Blog of HORAN Capital Advisors

    From The Blog of HORAN Capital Advisors

    The bright spot in these last two surveys is the fact the non-manufacturing survey continues to show strength as seen in the above chart. As reported by Econoday, "There may be export-related weakness in the manufacturing sector but it has yet to spill over to the overall economy. ISM's non-manufacturing index did slow 6 tenths to 55.3 in December but the level is still very solid and details are positive. New orders are up 7 tenths to a very strong 58.2 while employment is also up 7 tenths, to 55.7. The sample is building up inventories which hints at expectations for solid business ahead. Another positive is the export index which, like the ISM manufacturing report issued Monday, bounced solidly higher and back into the plus-50 growth column, at 53.5. Input prices show very little change. This report continues to be consistent and solid, underscoring the strength of the nation's domestic-based economy."

    In conclusion, the weaker aspects of the economy appear to be centered in the manufacturing sector and the energy sector. Importantly, the U.S. is a consumer led economy where manufacturing represents 12-14% and consumer and services represent the other 85%. The energy weakness is one were too much supply is straining companies with direct or indirect energy exposure. This growth in oil supply (green line) is evident in the below chart which was included in yesterday's post.

    From The Blog of HORAN Capital Advisors

    Aside from the marginal energy producers going out of business, a supply cut seems necessary to correct the demand/supply imbalance. Countries with state owned oil operations should be the most highly motivated to curtail supply. As the below chart indicates, many of these countries require oil prices that are significantly higher than where oil is trading today in order to balance their budgets. The risk these countries are facing beyound running out savings, is the potential to push the global economy into recession. In that situation demand declines and supply becomes an ever larger overhang. Oil could easily trade in the mid to low teens per barrel if this were to occur. We do not see a recession at the moment given the benefit lower energy prices have on the consumer segment of the economy.


    From The Blog of HORAN Capital Advisors