Friday, February 27, 2015

Market Advance Not Extraordinary In Terms Of Magnitude And Duration

In prior post over the past year I have highlighted the current market advance as it relates to prior bull markets. This information has been prepared by Chart of the Day and the below chart and commentary updates the comparison for the Dow Jones Industrial Average. The most recent commentary for the S&P 500 Index is included in the post, Current Stock Rally Below Average In Magnitude.
"The Dow just made another all-time record high. To provide some further perspective to the current Dow rally, all major market rallies of the last 115 years are plotted on today's chart. Each dot represents a major stock market rally as measured by the Dow with the majority of rallies referred to by a label which states the year in which the rally began. For today's chart, a rally is being defined as an advance that follows a 30% decline (i.e. a major bear market). As today's chart illustrates, the Dow has begun a major rally 13 times over the past 115 years which equates to an average of one rally every 8.8 years. It is also interesting to note that the duration and magnitude of each rally correlated fairly well with the linear regression line (gray upward sloping line). As it stands right now, the current Dow rally that began in March 2009 (blue dot labeled you are here) would be classified as below average in both duration and magnitude."
From The Blog of HORAN Capital Advisors

Tuesday, February 10, 2015

A Rising Bearish Wedge Pattern Is Developing In the S&P 500 Index

Near the end of October last year the S&P 500 Index moved into a sideways trading range that has seen the market move back and forth between 1,975 and 2,093. Then on December 19, a spike in up volume occurred that created the top of this trading range. Subsequent to this capitulation buying the market has struggled to recapture this December high mark with the market trading action forming a rising bearish wedge pattern. A rising wedge pattern tends to resolve itself with a market that breaks to the down side. Several highlights from the below chart.
  • The rising wedge is noted by the solid green and solid red lines. Also, the market is making lower highs as evidenced by the red dashed line.
  • The full stochastic indicator turned negative today with the fast green line dipping below the slower moving red line. This negative divergence has occurred at a level where the stochastic indicator shows the market is short term overbought.
  • Lastly, the on balance volume indicator (OBV) has trended lower since the start of the year. With the OBV, it is the trend of the line that is important. As noted on the website, "OBV rises when volume on up days outpaces volume on down days. OBV falls when volume on down days is stronger. A rising OBV reflects positive volume pressure that can lead to higher prices. Conversely, falling OBV reflects negative volume pressure that can foreshadow lower prices." The OBV often moves before a stocks price.

From The Blog of HORAN Capital Advisors

To provide another market perspective, Charles Kirk of The Kirk Report always provides insightful technical analysis during the week (small subscription required). In his strategy report tonight, he provides the below chart of the S&P 500 Index graphed in a 30 minute time frame and included the following analysis,
"By closing above swing resistance at S&P 2064 today, a new smaller bullish range breakout setup with a target at S&P 2141 has now triggered. Today’s rally also further developed the handle on the new cup setup we talked about in yesterday’s report and which you can also see in the 30 minute view below but needs to trade above last Friday’s intraday high at S&P 2072 to fire."
From The Blog of HORAN Capital Advisors

"With the attempted small range breakout in motion, it is now important that we see sustained bullish upside follow through to confirm. The first step would be to clear and hold above last Friday’s high at S&P 2072 and then take out the prior early December swing high at S&P 2079. If those levels are broken all that would remain is the December high at S&P 2093. If we are to now move away from this multi-month trading range, we will need to see sustained bullish upside follow through. In sum, this is the bulls’ best chance yet to try to put this trading range behind it. Whether it can hold above the smaller range is key."
In conclusion, I think Charles Kirk's analysis and mine are telling a similar technical story. The key is the fact the market needs to break resistance at the S&P 500 December high of 2,093. However, I believe the on balance volume indicator and the stochastic indicator are suggesting the market may trade lower before pushing through this December high level.

Saturday, February 07, 2015

A Strong Dollar Does Not Mean Large Cap U.S. Multinationals Underperfom Small Cap Equities

The US Dollar has been on a strengthening trajectory since early 2011 and more so since mid year last year. This move in the Dollar has been a headwind for U.S. domiciled multinational companies earnings, with many firms citing this as a reason for earnings disappointment during this earnings reporting season.

From The Blog of HORAN Capital Advisors

One belief is investors can avoid this negative currency impact within their investment portfolio by focusing more on small company stocks since small caps are less exposed to this exchange rate risk. The thinking is small cap companies generate a larger percentage of their overall business from domestic sources versus the larger multinationals that generate a larger portion of their revenue from overseas. In fact this seems to be the case during the earlier phase of the Dollar's strengthening as the above chart shows small cap outperformance from 2010 through most of 2013. However, as the Dollar continues to strengthen, larger cap companies actually outperform small caps as occurred in the mid 1990s. This can be seen in the below chart that compares the relative return of large caps versus small caps (orange line) to the U.S. Dollar Index.

From The Blog of HORAN Capital Advisors

S&P Capital IQ provided additional analysis in a report released in late January titled, Don't Duck A Rising Buck. In the report S&P analyzed the performance of large cap stocks versus small cap stocks during bear markets and bull markets and compared the results to the trend of the U.S. Dollar. The report is a worthwhile read for investors. In short, the data suggests large cap companies actually outperform small cap companies in a rising Dollar environment when the overall equity market is in a bull market phase. This outperformance occurs when the Dollar Index rises above 95 (closed Friday just below 95.) The report contains a sector performance comparison as well.

From The Blog of HORAN Capital Advisors

There are several reasons this outperformance by large caps may occur when the Dollar Index is above 95 and when the equity market is in a bull phase. Foreign investors likely see the U.S. economy growing at a faster pace than other economies, and this is the case today. With this thinking, foreign investors will allocate investment funds to U.S. equities. In doing so, they tend to focus on larger multinational firms that are more broadly know. Additionally, larger equities are more likely to be more liquid. This additional investment flow into the U.S. and the investment in Dollar denominated assets further pushes the U.S. Dollar Index higher. For non U.S. investors then, they receive an additional return benefit from a positive currency exchange when Dollar's are converted back into their home currency.

Just one comment on small caps. At HORAN, we have been out of small cap equities since late 2013. A reason we chose to eliminate the category from our client allocations was partially due to the valuation of small cap stocks broadly. In a Reuters report today, Valuations May Hurt Small Caps, Despite Job Growth, the article cites the apparent overvaluation of small cap stocks. Specifically, the article notes,
"The trailing price-to-earnings ratio of the index is at 22.7, which is 40 percent more than its long-term average of 16.2. Its price-to-sales ratio of 1.6 is nearly 67 percent higher than its long-term average."
In summary, even though small caps are less exposed to overseas business, there are several factors that indicate large cap U.S. equities outperform in spite of the currency headwind. Additionally, the valuation of small cap stocks are likely to be a headwind for the small cap equity asset class.

Sunday, February 01, 2015

The S&P 500 Index Nearing A Technical Bounce Level?

The month of January was not kind to U.S. equity investors. The S&P 500 Index ended the month down 3.00% and the Dow Jones Industrial Average was down 3.58%. The small cap and mid cap indices did not fare much better. On the surface, European equities appeared to be a bright spot with the S&P Europe 350 Index up 7.27%. However, for a U.S. investor not hedging the Euro/Dollar currency exchange, virtually all of this gain was lost in the currency translation back to the Dollar. The S&P Europe 350 Index was up a marginal at .09% in US Dollars.

From a sector perspective, the defensive sectors were the bright spot as can be seen in the below graphic. For the month utilities were up 2.37% and Health Care was up 1.23%, A bit surprising was the weakness seen in the consumer discretionary sector which was down 3.06%. Consumers seem to be restraining their spending even though they are realizing a large savings at the gas pump.

From The Blog of HORAN Capital Advisors

From a technical perspective, the market is not at an extreme oversold level but has approached an important support level, the 150 day moving average. On Friday, the S&P 500 Index closed at 1994.99 which is just below the 150 day M.A of 1996.94 as can be seen in the below chart. The 50 day M.A. has served as important support for the market over the past three years.

From The Blog of HORAN Capital Advisors

Other technical indicators, such as the MACD and stochastic, are nearing levels indicative of a market that is nearing a potential bounce. In my mind though, these technical indicators could see a little more weakness before the market does move higher. The percentage of stocks trading above their 50 and 150 moving average also are not at extreme levels, but are at levels where market recoveries occurred in the rally during the last several years.

From The Blog of HORAN Capital Advisors

Of a bit of concern is individual investor sentiment seems to be shaking off this resent pullback. For example, the American Association of Individual Investors reported bullish investor sentiment increased seven percentage points to 44.17% last week, which is above the long term average of 39%. Additionally, the bull/bear spread widened to 21.78% from 6.35% in the prior week. The long term bull/bear ratio average is 8.6%.

From The Blog of HORAN Capital Advisors

Lastly, the CBOE equity put/call Ratio declined as of Friday to .68, which means a slight increase in investor bullishness. This, along with the AAII sentiment indicator, is a contrarian one and both would suggest a little market weakness before a bounce ensues. As noted before on our blog, these sentiment indicators are most predictive when at extreme levels though.

From The Blog of HORAN Capital Advisors

Consumers are a critical component to economic activity and what they say has not yet translated into what they are actually doing. However, positive consumer sentiment is likely to lead to an improving consumer sector as we move out of winter and into the summer. As Econoday noted last week, Friday's University of Michigan consumer sentiment report was another strong and positive one.
"Consumer sentiment held on to its very strong surge at the beginning of the month, ending January at 98.1 vs the mid-month reading of 98.2 and compared against 93.6 in December. The current conditions component extended its first half gain to 109.3 vs 108.3 at mid-month and against 104.8 in December. The comparison with December points to strength for January consumer activity. The expectations component ends January at 91.0 vs 91.6 at mid-month and 86.4 in December. Price expectations are low, at 2.5 percent for 1-year expectations, up 1 tenth from mid-month but down 3 tenths from December, while 5-year expectations remain at 2.8 percent, unchanged from both mid-month and December. Consumer spirits are now very strong but have yet to translate to a similar pickup in consumer spending."
From The Blog of HORAN Capital Advisors
Source: Econoday

For investors then, the market's action around the 150 day moving average in the days ahead will be important. The near oversold levels reached by the MACD and the stochastic indicators, just naming a few, are indicative of a market that is nearing a position where an oversold bounce could occur. Certainly of concern is the fact the S&P 500 Index has been making lower highs and lower lows so far this year.

Thursday, January 29, 2015

How To Profit From An Increase In Oil Prices When It Occurs

One investment vehicle that may seem appropriate for participating in an eventual rise in crude oil prices is to invest in an ETF that directly tracks crude oil itself. One such ETF is the United States Oil ETF, ticker USO. There are many others that can be found here. However, investors should be aware that many of these ETFs gain crude oil exposure using futures contracts. Consequently, the ETFs using futures will not track oil prices directly. Several key points investors should be aware of regarding ETFs and mutual funds that use futures contracts for investment exposure follows:
  • USO gains exposure to oil using futures contracts. The issue with utilizing futures contracts has to do with the shape of the futures curve for oil. In order for USO to maintain exposure to oil, the index manager must “roll forward” futures contracts for oil. If the futures curve predicts higher prices for oil in the future, this added cost to roll forward the oil contracts eats into USO’s return. As the below chart shows the WTI futures curve is in what is called contango. This means the curve is upward sloping, i.e., higher future oil prices expected by the market. As a result the USO investment loses money as contracts are rolled forward. This is known as negative roll yield. A recent article on the oil futures curve, Contango Widens, can be read on Bloomberg.
From The Blog of HORAN Capital Advisors
Source: eia

As noted in a recent Morningstar analysis for USO,
  • "in 2014 USO declined by 43%, close to WTI's spot price collapse of 46% for the year. However, in 2009 (the last time there was a sharp rebound in oil prices) USO gained 14%, while the spot price soared 78% higher [emphasis added]." The lagging performance of USO versus the price of oil is largely due due to the negative roll yield issue mentioned above.
So how can an investor benefit from an increase in crude oil prices? Below is a chart of USO, the ETF with ticker XLE and the price of West Texas Intermediate crude. As can be seen on the chart, the energy sector ETF, XLE (orange line), actually outperforms USO (red line) as energy prices began to rise in 2010 as noted by the circle on the chart.

From The Blog of HORAN Capital Advisors

In summary, if one believes oil prices will rise, investing in an ETF like XLE is likely a better way to profit from rising oil prices.

Saturday, January 24, 2015

Investor Letter Winter 2014: Expectations In The Coming Year

We recently published our final Investor Letter for 2014. In the letter we take a look at the market and economy in 2014 and our outlook for 2015. As we comment in the newsletter, investors will be faced with a number of issues in 2015, oil price volatility, currency issues, stimulus programs around the world, just to name a few factors. January has already started with market volatility that me be unsettling to investors. For further insight into our views for 2015, our Investor Letter can be accessed at the below link.

Thursday, January 22, 2015

Bullish Sentiment Declines But Not At An Extreme Level

The American Association of Individual Investors released their Sentiment Survey results for the week ending 1/21/2015. Bullish sentiment declined nine percentage points to 37.1% with all of the change going to the bearish camp. Bearish sentiment increased 9+ percentage points. As the below chart shows, this places the bullish sentiment near the average for this reading. Investors should keep in mind this contrarian sentiment indicator is most predictive of future market direction when readings are at extremes which is not the case this week.

From The Blog of HORAN Capital Advisors
Source: AAII

Monday, January 19, 2015

Four Consecutive Weeks Down For Equity Market Not A Common Occurrence

Since the end of the financial crisis, or better yet, the market bottom in March 2009, weekly market declines for the S&P 500 Index lasting four consecutive weeks or longer have been a somewhat rare occurrence. The most recent string of four consecutive weekly declines occurred the week of September 22, 2014 through the week of October 13, 2014. Prior to this 2014 four week decline, the last string of four consecutive weekly declines occurred in 2011 (7/25/2011 - 8/15/2011). Since the beginning of 1990, the market has experienced a total of 22 time periods, out of 1,306 weeks, where the S&P 500 Index declined for four or more consecutive weeks.

Last week the market fell 1.24% and this was the third weekly decline for the S&P 500 Index. As the below chart shows, the technical set up for the weekly chart for the S&P 500 Index is suggestive of potential market weakness in the coming week with a negative MACD indicator and a negative stochastic indicator.

From The Blog of HORAN Capital Advisors

On a shorter daily time frame though, the S&P Index's technical indicators are suggestive of a market that is oversold. Both the MACD and stochastic indicators appear to be bottoming, but both remain negative. This oversold condition is supportive of a short term bounce in the market. For another view on market levels to watch, readers might want to check the article, Stock Market Checkup: Levels To Watch On Major Indices and An Intermittent Bottom perhaps, but Swing Bottom in Question. Additionally, Thursday and Friday saw the market find support at the 150 day moving average. However, the market will need to digest the ECB's likely bond buying announcement on Thursday the 22nd and the Greece election results on the 25th. Either one of these announcements alone could be unsettling for the equity market in the short run.

From The Blog of HORAN Capital Advisors

Longer term, we remain positive about potential equity market returns this year, yet increased volatility will likely be more the norm than the exception. Lower gas prices will act as a tax cut for consumers and this impact has a greater influence on economic growth than the negative effects experienced by energy companies. Assuming the ECB announces a bond buying program, their form of quantitative easing, the US Dollar is likely to continue strengthening. The stronger Dollar and lower interest rates outside the U.S. will make U.S equities an attractive investment for many foreign investors. This additional flow of funds into U.S. stocks will provide positive support for U.S. equities.

Week Ahead Magazine: A Central Bank Throws In The Towel

Investors paying attention to the market last week witnessed something they may not see for the balance of their lives. The Swiss National Bank's surprise announcement that it would no longer try to maintain the Swiss Franc's currency peg resulted in the Franc/Euro exchange rate falling nearly 30% in a single day. In actuality, the collapse occurred within seconds of the announcement. This type of currency move speaks volumes about the unintended consequences of the quantitative easing programs being pursued by central banks around the world. Evercore ISI notes there have been forty easing moves by central banks around the globe in just the last three months. Investor should remain vigilant as they pursue investment opportunities in 2015.

From The Blog of HORAN Capital Advisors

This week's Week Ahead magazine contains a number of links to articles discussing the implications of the Swiss National Bank's policy change. Additionally, a number of articles contain updated commentary about the state of the energy markets. Maybe $50/bbl is the new near term top in energy prices with further downside ahead. At the end of the day, these lower energy prices should translate to more of an economic benefit to consumers than the negative implications from reduced earnings from the energy sector. Below is the link to this week's magazine.

Sunday, January 18, 2015

Hyman & Kim: U.S. Pulling Global Economies

One comment mentioned of late is the U.S. economy may be decoupling from the rest of the world economies. In Part 2 of Ed Hyman's and John Kim's interview (Part I of Interview) with Consuelo Mack on Wealthtrack, both Hyman and Kim believe it is not possible for the U.S. economy to decouple from the rest of the world at this point in time. The globalization of trade and manufacturing has created an interconnectedness that will be difficult to break. Both Hyman and Kim believe, however, that the economic strength in the U.S. is pulling along other economies around the world.

A large part of the interview is focused on markets outside the U.S. However, one investment area both expressed concern about was the liquidity of the bond market. The Volker Rule and Dodd Frank legislation have created a potential crisis in the bond market. These rules have reduced bond inventory of the Wall Street banks from $250 billion to $50 billion today. At the same time, retail investors have increased their bond exposure from $1.7 trillion to $3.5 trillion. If a crisis were to occur in fixed income, Wall Street does not have the ability to clear this level of trading. On October 15th the treasury bond market had what some traders call a flash crash. Themis Trading noted in an article at that time,
"The bond market appears to have fundamentally changed and no longer seems to have the built-in liquidity shock absorbers provided by traditional dealers. Some will say that Dodd-Frank caused this since dealers can no longer hold as much inventory. Some will say that this is just the natural evolution of electronic trading. But something is wrong when the safest bonds in the world experience such a rapid price move in such a short time period."
The below video also contains a good discussion on asset class allocations that readers/investors may find of interest.

Saturday, January 17, 2015

Shale Oil And Gas Production Projected To Increase In February

The battle between OPEC and shale fracking producers has pushed the price of oil down to levels unthinkable just a year ago. Both parties seem unwilling to reduce production to levels that would stem the decline in oil prices. This lower price level is certainly placing financial stress on a number of drillers and leveraged fracking companies as noted in the article, Money Dries Up for Oil and Gas, Layoffs Spread, Write-Offs Start.

From The Blog of HORAN Capital Advisors

In spite of the apparent difficulties facing drillers and shale fracking companies, production growth continues to be projected for oil and gas out of the shale regions in the U.S.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

The U.S. Energy Information Administration released its weekly petroleum report late last week and natural gas inventories declined 236 bcf.This draw-down still left natural gas storage levels higher than at the same time last year, 2,853 bcf versus 2,571 bcf last year.

The well known headwinds facing the various companies in the energy sector have yet to result in a reduction in oil and natural gas supplies. With the new layoff announcements, capital expenditure cuts and financing difficulties by some energy companies, a reduction in supply may ultimately be realized over the next several quarters. The market is anticipating some stabilization in crude prices as noted by the short term price chart for crude oil. However, this may be premature given the continued growth in oil and natural gas production levels as noted earlier. The end result is a continued increase in supply as reduced demand seems to be an issue as well. In the weekly petroleum report, the EIA noted, "U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 5.4 million barrels from the previous week. At 387.8 million barrels, U.S. crude oil inventories are at the highest level for this time of year in at least the last 80 years. [emphasis added]"

From The Blog of HORAN Capital Advisors