Sunday, September 14, 2014

Week Ahead Magazine: September 14, 2014

Although much of the economic news last week came in on the positive side, the major U.S. indices were unable to move to the upside. As we noted in our earlier post today, September And Beyond, investors seem focused on the Fed meeting this week and the Fed's viewpoint on the economy and timing of interest rate increases. In spite of the market pullback last week, the S&P 500 Index is down only 1.1% from the high reached on September 5th.

Potential market moving economic news in the coming week:
  • Industrial production (M)
  • Producer Price Index (T)
  • Consumer Price Index, FOMC Announcement (W)
  • Housing starts, jobless claims and Philly Fed Survey (Th)
  • Leading Indicators (F)
Given the potential shift on interest rate policy from the Fed, a number of article links in this week's magazine look at the frequency of stocks and bonds declining simultaneously--and it is not a frequent occurrence. Another article link evaluates the markets' performance during mid-term election cycles as well as the pre-election year. Lastly, several articles look at projected economic growth along with corporate actions around dividends and stock buybacks. Below is the link to the coming week's magazine.

September And Beyond

Taking a look at some technical and fundamental data points that have evolved in September, below we provide insight into our thoughts on the market over the next few quarters.

We look at a number of technical indicators, i.e., charting technicals, in an effort to gain some insight into investors' trading sentiment. A number of recent technical indicators have, what we would call, rolled over, which is a negative from a short term market direction point of view. As the below chart indicates, both the PPO and Stochastic indicators are indicating a negative trend for the S&P 500 Index.

From The Blog of HORAN Capital Advisors

However, according to the stock trader's almanac,
"September is still the worst performing month and it is beginning to live up to this reputation once again this year. Average losses since 1950 for September are: DJIA –0.8%, S&P 500 –0.5% and NASDAQ (since 1971) –0.5%."
So, although September tends to be a poor returning month for the market out of all months in a calendar year, the average losses are not significant. Further noted in the Almanac about September,
"Historically speaking September weakness has been a great time to load up on stocks ahead of the “Best Six Months” of the year, November to April and an even better time in midterm years ahead of the best two consecutive quarter span of the four-year-presidential-election cycle."

"The market’s sweet spot of the Four-Year Cycle begins in the fourth quarter of the midterm year (2014). The best two-quarter span runs from the fourth quarter of the midterm year through the first quarter of the pre-election year, averaging 15.3% for the Dow, 16.0% for the S&P 500 and an amazing 23.3% for NASDAQ. Pre-election Q2 is smoking too, the third best quarter of the cycle, creating a three quarter sweet spot from midterm Q4 to pre-election Q2. Applying these average gains to yesterday’s closing prices puts DJIA at 19675, S&P 500 at 2315 and NASDAQ at 5656 at the end of Q1 next year."
One factor we believe influenced the market last week is the coming week's 2-day Fed meeting beginning on Tuesday. The Fed announcement will be at 2:00pm on Wednesday. Some strategist are concerned about the Fed's end of quantitative easing in October, along with the Fed's focus on getting interest rates to a more normal (higher) level. Janet Yellen's indicators du jour are related to employment. On Friday, September 5, the August non farm payroll report of 142,000 was below the consensus estimate of 230,000. One would expect this weak number to indicate the Fed will not hike rates anytime soon. On the other hand, the August payroll number is nearly always revised and the market is anticipating a revision higher; hence, higher rates sooner versus later?

In the short run, at the onset of an increasing interest rate cycle, equities can face some headwind in the initial stages of rate increases. At HORAN, we do not see the Fed increasing interest rates before mid-2015 though. In anticipation of higher rates, the market can cause rates, especially longer term ones, to rise in advance of a Fed rate hike. Some of the equity market's weakness this month is related to this. For example, the 10-year treasury rate has increased from 2.33% at the end of August to 2.61% at Friday's close. Until a clearer perspective is gained on the Fed's rate view, we believe the 10-year trades in a range from 2.30% to 2.75%, maybe as high as 3%.

One factor keeping a lid on higher interest rates in the U.S. is the fact rates in the U.S. are much higher, relatively, than rates outside the U.S. A part of this rate differential is being driven by the ECB's desire to embark on a significant QE program as well. This is resulting in foreign investors allocating investment funds into U.S. bonds and other U.S. investment assets. Also, with the recent increase in U.S. interest rates, this has led to a strengthening U.S. Dollar as evidenced by the trade weighted U.S. Dollar Index below. Since July the Trade Weighted Dollar Index has increased from 76.5 to 78.7 in September.

From The Blog of HORAN Capital Advisors

A strengthening Dollar, versus other currencies, results in foreign investors gaining additional return when they convert the Dollar back into their home currency. A strong Dollar also results in imports being cheaper, the U.S. is a net importer, thus providing for potentially cheaper goods for consumers. A strong Dollar also results in oil prices declining which translates into cheaper gasoline at the pump. Therefore, cheaper import prices and cheaper gasoline can be a positive for U.S. consumers which can lead to improved retail spending. As noted by Econoday, Friday's retail sales number of .6% matched expectations, but July was revised higher at .3%. These retail numbers alone suggests the economy may be stronger than the labor market numbers might suggest. Consumers account for nearly 70% of GDP or economic growth, so this could lead to improved GDP growth in the U.S. During the last week of August, the second reading on second quarter GDP saw an increase to 4.2% versus 4.0% in the first reading at the end of July. Lastly, related to the consumer, we are seeing other commodity prices decline. For example, in agriculture, commodities such as corn have fallen over 27% since May. We believe this will eventually lead to lower beef, pork and chicken prices.

From a broad perspective, outside the U.S., economic data suggests economies are still growing. And although some recent data shows slowing economic activity abroad, the data is not suggesting contraction. On the margin then, foreign economies have stabilized.

With respect to geopolitical concerns and there certainly seems to be many. This type of risk might be reason enough for the market to climb that proverbial "wall-of-worry." The middle east issues do not have the same impact on the U.S. as in the past given the U.S.'s improved domestic energy market, primarily a result of fracking. Putin and his war in Ukraine is certainly one we continue to watch. The middle east and Ukraine issues are known and are likely mostly reflected in current asset prices. Of bigger concern might be the unknown unknown. It is this type of event that is not reflected in current asset prices.

In concluding, the market has had a great run since the end of the financial crisis. We are going on three years without the market incurring a 10%+ market correction. It would not surprise us to see one. Because corrections are difficult to predict or time, we do believe the structure of our client portfolios is such we would be able to fund client lifestyles without upsetting the long term return goals of a portfolio. And, at the end of the day, it is corporate earnings (cash flow) which ultimately drives stock prices in the long run. To that end, we continue to see improved earnings results and outlooks from corporations in their earnings reports. Ned Davis Research (via Charles Schwab) succinctly noted three potential market outcomes in their recent monthly market digest:


Breaking down the five-year run allows us (NDR) to identify the likely next phases. Below are three scenarios and likely leadership trends if each unfolds.

1. Escape Velocity
  • Description: Renewed corporate confidence leads to more hiring and capex. The Fed would be able to normalize policy as real GDP approaches 3-3.5%.
  • Leadership: Dividend (and to a lesser extent buyback) fixation could be replaced by capex beneficiaries. Mid and late-cycle sectors such as Industrials, Energy, and Technology have capex support. Styles could be less Growth-oriented.
2. Bubble
  • Description: If escape velocity is unattainable at this time, the Fed may choose to remain extremely accommodative by not raising short-term rates or even instituting QE4. The combination of the Fed’s forcing investors into riskier assets and lack of earnings growth could push valuations to levels not seen since the late 1990s Tech bubble.
  • Leadership: Bubble phase - Growth stocks that can deliver in a slow-growth environment and yield plays.
  • Bubble aftermath – defensive sectors not caught in the bubble.
3. Valuation Correction
  • Description: If the economy fails to reach escape velocity but the Fed normalizes policy, then stretched valuations suggest the market is vulnerable to a correction. As long as a recession is avoided, any correction should be limited to less than 20%. Continued modest earnings growth would lower multiples.
  • Leadership: Large-caps over small-caps.
  • Defensive Value sectors, which would benefit from the likely decline in long-term interest rates during a correction.

Sunday, September 07, 2014

Risk Versus Volatility

Howard Marks, Chairman of Oaktree Capital Markets released his most recent client letter, Risk Revisted. As Marks notes in his letter, he dedicated three chapters of his book, The Most Important Thing, on the subject of risk. In his client letter, he expands on risk and discusses 24 different forms of risk. A couple of highlights from his client letter:
  • There’s little I believe in more than Albert Einstein’s observation: “Not everything that counts can be counted, and not everything that can be counted counts.” I’d rather have an order-of-magnitude approximation of risk from an expert than a precise figure from a highly educated statistician who knows less about the underlying investments. British philosopher and logician Carveth Read put it this way: “It is better to be vaguely right than exactly wrong.”
  • No ambiguity is evident when we view the past. Only the things that happened happened. But that definiteness doesn’t mean the process that creates outcomes is clear-cut and dependable. Many things could have happened in each case in the past, and the fact that only one did happen understates the variability that existed. What I mean to say (inspired by Nicolas Nassim Taleb’s Fooled by Randomness) is that the history that took place is only one version of what it could have been. If you accept this, then the relevance of history to the future is much more limited than may appear to be the case.
  • Knowing the probabilities doesn’t mean you know what’s going to happen.
  • Bruce Newberg says, “There’s a big difference between probability and outcome.” Unlikely things happen–and likely things fail to happen–all the time. Probabilities are likelihoods and very far from certainties.
His letter is a worthwhile reading for investors. The potential risks facing investors searching for yield is elevated in an environment where the Fed has pushed interest rates to near zero. Equally, the search for capital appreciation is equally challenging as equity prices are no longer at levels reached subsequent to the financial crisis.

Week Ahead Magazine: September 7, 2014

Last week's holiday shortened trading saw fractional gains in most major U.S equity indexes except for the small cap Russell 200 Index. The small cap index declined .4% on the week and only remains up .6% for the year. Small caps continue to lag the broader S&P 500 Index which is higher by 8.6% year to date through Friday's close. The one piece of weak economic news reported last week was the +142,000 increase in non-farm payrolls. The consensus estimate prior to the release was an anticipated increase of 230,000. The market seemed to shake off this miss as the month of August tends to be a particular month that is frequently revised.

The coming week will be light on potential market moving economic reports. Jobless claims will be reported Thursday and retail sales will be reported on Friday. Given the importance of the consumer on GDP, the retail report will be watched closely. The magazine link below includes an article by  Liz Ann Sonders of Charles Schwab highlights sentiment data, GDP component changes from Q1 to Q2 and a number of additional pros and cons on recent economic data.

Lastly, the U.S. market has managed to dismiss geopolitical events around the globe. An event that will take place on September 18th is the Scottish referendum to separate from the United Kingdom. A couple of articles in the magazine touch on the potential significance if the referendum is approved by the Scottish citizens.

Thursday, September 04, 2014

Individual Investors Not Overly Bullish

This week's sentiment survey from the American Association of Individual Investors notes bullish sentiment declined 7.25 percentage points to 44.67%. Two thirds of the decline went into the bearish category while the other one third went into the neutral category.  A less volatile measure is the 8-period moving average of the bullish sentiment reading and it rose to 38.3% from last week's 37.4%. The 8-period moving average is not indicating either an overly bullish sentiment or an overly bearish sentiment environment.

From The Blog of HORAN Capital Advisors
Data source: AAII

As a point of reference, 2013 saw strong market returns from the S&P 500 Index and sentiment readings at the end of 2012 compared to this latest report are noted below.

From The Blog of HORAN Capital Advisors

Wednesday, September 03, 2014

Current Stock Rally Below Average In Magnitude

"With the S&P 500 trading above 2,000 for the first time in history, today's chart provides some perspective to current rally by plotting all major S&P 500 rallies of the last 82 years. With the S&P 500 up 91% since its October 2011 lows (the 2011 correction resulted in a significant 19.4% decline), the current rally is slightly below average in magnitude above average in duration. In fact, of the 23 rallies plotted on today's chart, the current rally would rank 7th in duration."

- A major stock market rally has been defined as a S&P 500 gain of 30% or more (following a correction of at least 15%).
- The S&P 500 was not adjusted for inflation or dividends.
- Selected rallies were labeled with the year in which they began.
- There are 252 trading days in a year (100 trading days equal about 4.8 calendar months).

From The Blog of HORAN Capital Advisors

Could there be more upside? The Wall Street Journal has an article out today noting, "Stocks have risen in eight of the past 10 Septembers, with the lone outliers coming in 2008 (the worst of the financial crisis) and 2011 (the middle of the European debt crisis and one month after the downgrade of the U.S. credit rating)."

Tuesday, September 02, 2014

Dividend Payers' Return Lags Non Payers In August

The equal weighted return of the dividend payers in the S&P 500 Index continues to lag the return of the non payers in August. As a consolation though, the payers equal weighted return is ahead of the cap weighted S&P 500 Index on a YTD and 12-month basis.

From The Blog of HORAN Capital Advisors

This equal weighted outperformance of the non-payers has carried over into the performance of Guggenheim's equal weighted S&P 500 Index (RSP) versus the cap weighted S&P Index as noted in the below chart. A number of the larger cap dividend payers have struggled on a year to date basis with a number falling in the consumer discretionary sector and industrial sector. For example, on a price only basis, Boeing (BA) is down 7.10%, United Technologies (UTX) is down 5.11%, General Electric (GE) down 7.31%, Best Buy (BBY) down 20.04% and Bed Bath & Beyond (BBBY) is down 19.98%.

From The Blog of HORAN Capital Advisors

Disclosure: Family long GE and UTX

Monday, September 01, 2014

Week Ahead Magazine: August 31, 2014

The strong equity returns in the just completed month of August prove historical expectations do not always play out as the data might suggest. As we noted in our post just before August began, Is This The Much Awaited Market Pullback?, the average August return for the past 10 years has been negative.

From The Blog of HORAN Capital Advisors

With the strong August returns several market pundits are reiterating their often repeated call for a major market correction. A correction would not surprise us, but we do not see the 30 - 60% that is predicted by some investment managers. Several article links in this week's magazine provide insight into these repeated correction calls; one by Barry Ritholtz on David Tice's correction call and the other by Larry Swedroe covering John Hussman's bear market point of view.

The coming week is a holiday shortened one with a number of important economic reports. Most watched will be the data surrounding employment. Jobless claims will be reported on Thursday and the employment situation report will be released on Friday. The employment data is getting closer scrutiny as Janet Yellen has noted the labor market is weaker than it should be. Econoday notes, the employment report likely will play a key role in the next round of Fed forecasts for the economy, posted with the September 17 FOMC statement."The key question is when will the Fed begin to raise rates.

Making up for the light article links from last week, the Monday holiday allowed for me to include a few more articles that might be of interest for the coming week. Below is the link for this week's magazine.

Sunday, August 31, 2014

Achieving Excess Returns Around FOMC Meetings

David Blitzer, Chairman of the Index Committee for S&P Dow Jones Indices, recently highlighted research results showing excess returns are generated around FOMC meeting dates. The research paper, Stock Returns Over The FOMC Cycle, evaluates the average 5-day return minus the treasury bill rate. The paper shows statistically significant excess returns are generated in the five day period in advance of the FOMC announcement.

From The Blog of HORAN Capital Advisors

The paper notes the FOMC meeting dates are "quite irregular" and "'even' weeks in FOMC cycle time do not line up with other macro releases that would be influencing returns."

Lastly, the paper looks at the unintended (and intended) information release that comes from the Fed. The report notes, "Overall, it is possible that the bi-weekly patterns in average excess stock returns and fed funds futures volatility result from both subtle intentional and unintentional communication coming from the Fed. The precise mechanism remains a central issue for understanding the economics behind our newly documented asset return patterns and an avenue that we (and hopefully others) will explore."

As S&P's David Blitzer notes in his article title, investors look for short term trading gains might consider to "Sell Just Before, Not After, the FOMC Meets."

Sunday, August 24, 2014

Week Ahead Magazine: August 24, 2014

This past week saw the S&P 500 Index set a record closing price of 1,992.37 on Thursday. One article in this week's magazine notes the equity market has gone over 1,020 days without a 10% correction. Investors seem content on buying market "dips". This most recent dip saw the market decline 3.94% from its July 24th closing price down to 1,909.57 on August 7th. The "V-shaped" recovery from August 7th has seen the market advance 4.3% to Friday's close.

From The Blog of HORAN Capital Advisors

The only major U.S. index that remains negative for the year is the small cap Russell 2000 Index which is down .3%. The leader is the Nasdaq composite index which is up 8.7% followed by the S&P 500 Index, up 7.6%. The Dow Jones Industrial Average remains the laggard and is up 2.6% on the year.

Much of the focus this past week was on Janet Yellen's Jackson Hole presentation. The comments had little market impact with treasury yields rising just slightly across most of the interest rate curve. Most of the economic news last week was fairly positive. As we noted in our earlier post today, manufacturing, leading indicator data and jobs data seem to be supportive of a positive economic climate looking out to year end. From an international perspective, economic data remains mixed and saw weakening in most area's Purchasing Managers Indices.

A number of economic data releases are scheduled to be reported this week. Some of the potential market moving reports are:
  • New home sales (M)
  • Durable Goods Orders (T)
  • GDP and jobless claims (Th)
  • Personal Income and Outlays (F)
The magazine as well as blog posting has been lighter this week as we were visiting out of town clients during the first half of the week. Below is the link to this week's magazine.

Fundamentals Creating A Positive Environment For Equity Markets In Second Half Of Year

Almost two weeks ago we noted the S&P 500 Index appeared to look more attractive from a technical perspective. Since the market reached a near term low of 1,909.57 on August 7th, the S&P 500 Index has rallied 4.13% through Friday to close at 1,988.40. In addition to a positive technical perspective at that time, recent economic and company reports indicate potential strength ahead. In looking at several economic factors, last week's report on The Conference Board's Leading Economic Index showed an increase of .9% in July, which followed a .6% increase in both May and June. On August 15th the Federal Reserve reported the sixth straight monthly increase in industrial production with July's increase of .4%.

From The Blog of HORAN Capital Advisors

The continued improvement in the LEI Index and industrial production is showing up in the ISM non-manufacturing survey, specifically in new orders. The report noted,
"the New Orders Index registered 64.9 percent, 3.7 percentage points higher than the reading of 61.2 percent registered in June. This represents the highest reading for the New Orders Index since August 2005 when it registered 65.3 percent."
The early August report notes respondents indicating strength in the second half of this year as well. A couple of direct highlights from the report:
  • "Conditions are improving." (Construction)
  • "Slight improvement in the economy, but still experiencing delays in client project start-ups. Expecting some improvement in 4th quarter." (Professional, Scientific & Technical Services)
  • "Second half of the year is looking promising for increased orders versus last year." (Information)
  • "Business is still very good. Expecting continued growth in the 2nd half of the year." (Retail Trade)
  • "Business has been strong this summer after a late start due to the poor spring weather." (Wholesale Trade)
From The Blog of HORAN Capital Advisors

Lastly, with the second quarter 2014 earnings season essentially at an end with 486 companies having reported, the year over year growth rate for earnings in the quarter came in at 10.2% (excluding Citigroup (C)). It is not anticipated the remaining companies yet to report will change the 10+% growth rate. Thomson Reuters notes, if this growth rate holds, it will represent the second highest quarterly growth rate since the fourth quarter of 2011. The revenue growth rate recorded so far in Q2 is 4.6% with the health care sector leading the way with revenue growth of 12.2% in Q2.

Investors and strategist may be viewing the coming end of QE as a brick wall for the economy. However, current economic reports and company reports are suggesting the economy may be able to function without outside stimulus. I have not touched on the improvement in the job market, but this is another positive as well. I will highlight some of these items in our Week Ahead Magazine post, but several market moving reports in the coming week include the second reading on Q2 GDP and jobless claims on Thursday.

Disclosure: No position in C

Sunday, August 17, 2014

Week Ahead Magazine For August 17, 2014

After the market's close this past Tuesday we wrote a post discussing how the market technicals had turned more positive and the market did not disappoint. For this past week the equity market did turn higher with the major U.S. indices posting weekly gains. The standout was the Nasdaq Composite Index returning 2.2% and now up 6.9% on the year. The much watched small cap index, the Russell 2000, managed to generate a gain of .9%; however, the index remains down 1.9% year to date. Last week's news was dominated by geopolitical issues, e.g., the Ukraine/Russia conflict. The issues taking place on the European continent seem to be impacting economic and consumer sentiment in the Euro Zone. As Econoday noted in their weekly recap,
"Numbers for second quarter GDP for France, Germany, and the EU fell below expectations—including a negative number for German GDP, largely damped by Ukraine concern. It was more current news that lifted stocks after President Vladimir Putin said Russia will work to stop the conflict in eastern Ukraine. Equities were mixed Friday on a report that Ukraine government forces attacked an armed convoy from Russia—allegedly carrying humanitarian aid."
The highlight for this week may be commentary from the Fed Symposium at Jackson Hole. This event has taken place since 1978 and this year's topic will be "Re-Evaluating Labor Market Dynamics." In the interim, potential market moving economic reports for the coming week include:
  • Consumer Price Index and Housing Starts (M)
  • FOMC Minutes (W)
  • Jobless Claims, Philadelphia Fed Survey and Existing Homes Sales (Th)
Articles of interest can be found in this week's magazine with the link provided below.

Wednesday, August 13, 2014

Market Technicals Turn More Positive

Short term technicals for the S&P 500 Index have turned more positive after the market's recent pullback. As the below chart shows, the 100 day moving average has served as important support for the market over the past year and a half. Each time the market has experienced a pullback, the market has managed to bounce off of the 100 day moving average line. Additionally, the full stochastic oscillator has begun to turn higher from an oversold level. The vertical dotted lines on the chart display areas where this indicator began to turn higher and where the S&P 500 Index bounced off of its 100 day moving average. The money flow index (MFI) declined to a level near where an oversold market would be indicated (< 20) and may be bottoming and attempting to turn higher. The MFI incorporates volume and is another version of the relative strength index. With volume included in the calculation, some believe volume leads price; therefore, increasing volume at a time the market is turning higher can be indicative of a market move higher.

From The Blog of HORAN Capital Advisors

From a fundamental perspective, earnings in the second quarter are expected to increase by 8.2%. When looking at earnings that exclude Citigroup's (C) earnings report, Q2 earnings are expected to be higher by 10%. We have not seen double digit earnings growth (ex Citigroup) since 2011. Third quarter earnings growth expectations equal 9.3% and fourth quarter growth expectations equal 12.2%. With strong earnings reports from companies and a market that seems to have worked off oversold conditions, higher prices may be realized if not just in the second half of August, but through the balance of the year. Of course, geopolitical issues are a wild card as well as the mid term election in the U.S. in November.

Disclosure: No position in C