Wednesday, April 23, 2014

Investors Holding Cash Confounded By Market Action

Until today, when the S&P 500 Index declined .22%, the market had managed to move higher on the prior six trading days. The six day climb followed what some investors thought might be a correction beginning to take place in the market.
  • On April 2nd the S&P reached 1891 before declining 4% to 1816 on April 11th.
  • The six subsequent trading days saw the S&P 500 Index rise 64 points to 1880, nearly recapturing the high reached on April 2nd.
This type of trading action has been the norm for this market going back to mid year 2013. I prepared the below chart late last night and was motivated to post it here following a similar chart highlighted today by Charles Kirk of The Kirk Report. The red 150 day moving average line has served as an important support level for the market for the past year and a half.

From The Blog of HORAN Capital Advisors

Charles Kirk commented, "this is also why the short-term quant data suggests new highs versus more traditional metrics." Putting Kirk's comment another way, algorithmic trading has been "programmed" to trade these patterns. Until we see a breakdown of this pattern type trading, the markets will likely move in the direction of its current longer term trend and that is higher at the moment.

The absence of a market correction, i.e., a decline of at least 10+% has confounded some investors. A chart making the rounds on the internet today is the one below. The chart resembles the trading set ups in the shaded boxes in the above chart.

From The Blog of HORAN Capital Advisors

Further influencing investor sentiment is the trading action of stocks following their earnings announcements, like Apple's (AAPL) stock price action tonight. Apple reported earnings tonight and once trading resumed in the stock Apple's shares traded $40 higher or a gain of 8% in after hours trading. More detail needs to be gleaned from the conference call, but Howard Silverblatt of S&P Dow Jones Indices noted the stock buyback impact reduced share count by 3.4% resulting in an EPS increase for the March quarter of 15.2% versus the March 2013 quarter. Net income though only increased 7.1%. If one needed an example of a breakdown of the Efficient Market Hypothesis, this might be a good place to start.

Disclosure: Family long AAPL


Tuesday, April 22, 2014

Investor Letter Spring 2014: The Weather Is To Blame

As we noted in our fourth quarter Investor Letter, we cautioned investors about looking at past returns and projecting those into the future. The first quarter of this year was a perfect example where returns in 2013 did not carry over into the first quarter. Our Spring 2014 Investor Letter provides commentary on the rotation that has occurred in the market during the first quarter. What makes the economic assessment more difficult at the moment is the fact this winter's weather was some of the worst in recorded history, not only in the Midwest, but across the entire U.S. The Southeast even experienced snow this winter. Below is the link to our Spring Investor Letter that provides our review of the quarter and insight in to the year ahead. For our clients and readers, we appreciate the confidence you have placed in us and always welcome your comments.

From The Blog of HORAN Capital Advisors


Sunday, April 20, 2014

Week Ahead Magazine: April 20, 2014

Nearly four months into the trading year and the market indices have essentially traded sideways from the beginning of the year to Thursday's close. The S&P 500 Index is up .89%, the Nasdaq 100 is down 1.60% and the S&P SmallCap 600 Index is down 1.17%. On the other hand, as we noted in a post late last week, certain segments of the market have experienced significant corrections: social media and biotech, for example. One link in this week's magazine is an article written by Ben Carlson of the site, A Wealth of Common Sense. One recent article, Financial Matters, is one every investor should read as it contains an interesting list of factors investors should and should not focus on. Below is the link to articles for the coming week.


Saturday, April 19, 2014

Dow Dogs Are Front Of The Pack

Interestingly, we last highlighted the Dogs of the Dow strategy about this time last year and at that time the Dow Dogs were outperforming the overall Dow Jones Industrial Average Index. For all of 2013 the Dow Dogs of last year outperformed the Dow Index as well as the S&P 500 Index. As we turn our attention to 2014, the Dogs of the Dow are again outperforming many of the broader market indices except for the utility index and the transportation index. The Dow Dog strategy consists of selecting 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 prior year. Once the ten stocks are determined, an investor would invest an equal dollar amount in each of the ten stocks and hold them for the entire year. Investors should note the strategy has generated mixed results over the years though.

Below is the year to date performance of the Dow Dogs through the market close on 4/17/2014. Below the table is a listing of the performance of a few market indices for this year as well. The year to date outperformance of this strategy is in line with the recent rotation occurring within the market from growth style equities to value style equities.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors


Sunday, April 13, 2014

Week Ahead Magazine: April 13, 2014

Many of the links in this week's magazine cover commentary about the recent rotation that appears to be occurring within the equity market. Additionally, several article links provide insight into important economic reports for the coming week. Lastly, earnings season for the first quarter kicks into high gear with a number of companies reporting this week and next. The link to this week's magazine is provided below.


The Downside To Chasing Prior Winning Strategies

We have discussed the potentially negative investment consequences resulting from investors projecting recent outcomes into the future, recency bias. One key for investors to keep in mind is to determine if a recent result is the beginning of a longer term trend either up or down. What is difficult in this type of assessment is trends are not of equal duration. The first chart below shows small cap stocks have outperformed large cap stocks since the end of the bursting of the technology bubble in 2002 (nearly 12 years). The second chart compares the biotechnology ETF, IBB, to the S&P 500 Index. Biotechs have been outperforming the broader market since mid 2011 (almost 3 years). As we noted in yesterday's post, biotech performance has been much weaker over the course of the past several months than the broader market. Is this the end of the biotech outperformance trend?

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

In addition to the above market segments, small cap and biotechs, trend reversals from 2013 are also evident. In a recent comment by Charlie Bilello, CMT of Pension Partners, he compares the returns of certain market segments in 2013 versus 2014. A number of the better performing market segments in 2013 have now turned out to be the weaker ones in 2014 and vice versa.

From The Blog of HORAN Capital Advisors

Simply chasing last years winners or jumping into a trend trade too late or even too early, can have negative consequences for the return of one's investment portfolio.



Saturday, April 12, 2014

The Market Beyond First Quarter 2014

Five out of the last six trading days have seen the Dow Jones Industrial Average rise or fall by more than 100 points. This type of market volatility certainly can be unsettling to investors. In addition to these 100 point plus or minus swings, is the increased commentary by some well known market strategists that are calling for a significant downturn in the market. In spite of this volatility and the rhetoric on television news shows, the S&P 500 Index is down less than 4% from its high and only down 1.8% year to date.

The cause of the bearish market view is partly attributable to the correction occurring in some parts of the market. As the below chart shows, two sub-sectors of the market that have corrected significantly are the biotechnology companies (IBB) and the social media stocks (SOCL). A couple of the safehaven sectors, utilities and consumer staples, have held up well since the two momentum sectors below began to correct beginning in late February.

From The Blog of HORAN Capital Advisors

So, in reality, investors have found a reason to rotate out of the momentum sectors. From a positive perspective, this has brought the valuations of some of the momentum stocks back down to a more reasonable level.

Another area of the market being impacted by this rotation is the rotation out of growth type stocks to value stocks. We discussed this in an article in late March, Why It Matters That Value Stocks Are Outperforming Growth Stocks. This rotation into value is continuing and is evident in the updated chart below.

From The Blog of HORAN Capital Advisors

This type of market environment provides the bears with a platform from which they can voice their bearish market point of view. Bullish investors need to pay attention and evaluate the points raised from the bears. Importantly though, the market's direction will trend in the direction of expected future earnings growth and the anticipated growth of the economy. From an earnings perspective, the first quarter of 2014 is shaping up to be a weak one. In a recent report from Factset, they note earnings are estimated to decline 1.6% in the first quarter. If this is realized, the Q1 2014 decline would be the first since earnings declined 1.0% in the third quarter of 2012 (2013 turned out to be a good one for S&P 500 stocks). The Factset report contains highlights from some companies that have implicated the harsh winter weather experienced in the first quarter as contributing meaningfully to weaker Q1 earnings. When companies miss earnings or lower guidance, they like to find a scapegoat that is something other than an internal operating issue--the weather is the scapegoat in Q1. However, we do believe the weather is a valid factor that has contributed to Q1 earnings weakness and may likely reverse itself in the last three quarters of 2014.

From The Blog of HORAN Capital Advisors

What is an investor to do in a market like being experienced at this point in time? One investor that is gaining a great deal of press recently is Marc Faber.  Mr. Faber is predicting that the 2014 correction will be worse than the correction experienced in 1987. My problem with his correction call is the following:
I suppose if one always calls for a correction, they will eventually be right. And if Marc Faber is finally right that a 1987 style correction is in store for the market this year, should one sit out the market now.

Below is a chart of the S&P 500 Index going back to 1986. The chart clearly shows the 1987 correction when the S&P fell over 57 points to 282. About a year and a half later (April, 1989), if an investor stayed invested in the market, they would have recovered entirely from the decline.

From The Blog of HORAN Capital Advisors

In conclusion, corrections are difficult to predict. In fact, I do not know any famous market timers. One of many keys to surviving a correction is to have an appropriate allocation in one's investment account that can fund one's lifestyle without the need to sell stocks right after a significant correction. In that regard, I recommend investors read Howard Marks recent newsletter, Dare to Be Great. A few highlights from his report:
  • How do you think about risk? Is it volatility or the probability of permanent loss? Can it be predicted and quantified a priori? What’s the best way to manage it?
  • How reliably do you believe a disciplined process will produce the desired results? That is, how do you view the question of determinism versus randomness?
  • Most importantly for the purposes of this memo, how will you define success, and what risks will you take to achieve it? In short, in trying to be right, are you willing to bear the inescapable risk of being wrong?
  • The real question is whether you dare to do the things that are necessary in order to be great. Are you willing to be different, and are you willing to be wrong? In order to have a chance at great results, you have to be open to being both.


Thursday, April 10, 2014

Bullish Sentiment Reading A Positive Data Point For Stocks

This morning the American Association of Individual Investors reported individual bullish investor sentiment decline 6.9 percentage points to 28.5%. This compares to the February 6, 2014 level when bullish sentiment was reported at 27.9%. All of the decline in bullish showed up in the bearishness reading that rose 7.3% to 34.1%. The 8-week moving average of the bullishness reading declined to 36.9% and is the lowest level since this average was reported at 35.8% in mid July of 2013. For investors, this measure is a contrarian one and is most accurate at its extreme. This week's lower bullishness level is one that is approaching an extreme and in and of itself is one a positive reading for the future direction of the equity market if one is a bull.

From The Blog of HORAN Capital Advisors


Monday, April 07, 2014

Week Ahead Magazine: April 6, 2014

In spite of the weak finish to the market on Friday, most U.S. equity indices ended higher on the week. The Dow Jones Industrial Average and the S&P 500 Index finished the week up .5% and .4%, respectfully. The NASDAQ though declined 1.2% as many momentum related stocks experienced the brunt of the sell off. Economic data is pretty light this week with FOMC minutes being released on Wednesday, jobless claims on Thursday and PPI and consumer sentiment on Friday. One article in this week's magazine notes forward four quarter earning estimates for the S&P 500 Index are rising. Additionally, one of our articles notes the low bar that has been set for earnings in the first quarter. If earnings are accelerating and we start seeing a number of earnings beats for S&P 500 companies the market could be setting itself up for a rebound.

At a recent market seminar, Ned Davis Research provided a sentiment trading chart that notes trading sentiment has moved into the extreme pessimism zone. Certainly there are seasonal hurdles to overcome as we are nearing a potentially weak market period that has occurred during mid term election cycles. Below is the link to this week's magazine.


Sunday, April 06, 2014

The Labor Force Participation Rate: Now A Controversial Variable

If there is one seemingly boring economic statistic that is now creating a lot of controversy it is the continuing decline in the labor force participation rate. Much of the debate around this statistic is important because it provides insight into the health of the economy and more importantly the labor market. As can be seen in the below chart, the participation rate (maroon line) is now at a level reached in 1978.

From The Blog of HORAN Capital Advisors

I surmise if we could go back to 2007 and rewrite history so the financial crisis and resulting recession never occurred as well as no quantitative easing programs, the labor force participation rate would not be on many economists and non-economists radar. However, the angst this statistic can cause spiked last week when the Wall Street Journal reported on Friday's Employment Situation report, U.S. Reaches a Milestone on Lost Jobs. One factor in the report that stimulated some interest was the below chart that is included in the WSJ article.

From The Blog of HORAN Capital Advisors

In a response to the article, Bill McBride author of the well written Calculated Risk website, wrote an article indicating the Journal needed to post a correction to its article. The main point made in the Calculated Risk article is the Wall Street Journal's above graph ignores the demographic impact on the participation rate. Bill's article, WSJ Employment Graph ignores Demographics, Needs Correction, provides his viewpoint on the Journal's take on the payroll report.

In an article written in Investor's Business Daily, Hold The Champagne On That Job Report, this article notes the labor force has grown by 12.2 million participants. The IBD article uses the current labor force participation rate and notes, "That means just to get back to where we were when the recession started — based on a labor force participation rate of 63.2% — we have to create at least 8 million more private-sector jobs. Even if the workforce didn't grow at all, it would take us more than 3 1/2 years."

James Bullard, Chief Executive Office of the Federal Reserve Bank of St. Louis, is weighing in on the participation rate decline as well. In a paper he released in the first quarter of 2014, The Rise and Fall of the Labor Force Participation in the United States, he points to the heightened interest being placed on this indicator.
"Labor force participation in the United States has been a controversial subject in current macroeconomic discussions...The participation rate - a measure of the number of people actively involved in labor markets - has generally been a secondary concern in macroeconomics. However, with recent sharp declines following the financial crisis and recession of 2007-2009, it has suddenly become a salient topic, and one that gets discussed even in non-economic settings."

"At its broadest level, the debate about the labor force participation rate is a debate about the nature of the U.S. economy over the 4½ years since the end of the recession in the summer of 2009. Should we characterize the economy as substantially back to normal following the very severe recession? Or, has little progress really been made, so that the economy remains far from its potential?"

"There are clear lines of argument on both sides, sometimes blurring political boundaries. Some suggest that the extraordinary policy response since the end of the recession has been largely ineffectual, perhaps citing the very flat employment-to-population ratio since 2009, and that their own suggested policy responses would have produced better outcomes...." (emphasis added)
In the Bullard paper, he notes the steady rise in the participation rate from 1980 to 2000. Subsequent to 2000 the participation rate has mostly been on a decline. He does believe demographics has played a roll in the rise and now decline of the participation rate. From the late 1940s to mid 1960s the participation rate was fairly stable at 59.1%. Additionally, economic activity was pretty good during this period of a lower participation level. In the Bullard paper he notes several studies projecting future participation rate levels. In one such study, the participation rate is expected to decline steadily, or by 15 basis points, to the year 2022. In this study, 70% of the decline is attributable to demographic factors like baby boomer retirements. Several other studies are cited in the Bullard paper, but he is clear that further work needs to be done on this topic.

Lastly, if the participation rate decline is due to demographic factors, one might expect to see changes in the number of individuals receiving social security benefits that are directly attributable to retirements. The below chart shows the annual change in individuals receiving benefit payments from social security strictly as a result of retirement. For the four years from 2009 to 2012, a net of over four million individuals joined the social security system due to retirement. The below chart is certainly on a trend that would forecast net new beneficiaries for social security in excess of one million individuals annually.

From The Blog of HORAN Capital Advisors

Certainly, more work needs to be done in the area of participation. I believe it is fairly clear though that demographic effects are having a large impact in the declining participation rate itself. However, as the IBD article referenced above notes, the labor force has grown by 12.2 million individuals since the recession began. Maybe the current 63.2% participation rate is not the appropriate long run percentage, maybe it is several percentage points lower, but the economy is still not operating at full employment. The Fed is obviously looking at the unemployment rate, which continues to slowly improve, and they may be placing less weight on the participation rate.


Friday, April 04, 2014

Dividend Payers Bounce Back In March

For the month of March the dividend payers in the S&P 500 Index regained their footing and outperformed the non payers by a full 3.75 percentage points. In spite of this outperformance by the payers in March, the payers return continues to significantly trail the non payers return on a year to date and 12-month basis.

From The Blog of HORAN Capital Advisors

For investors though, is the outperformance by the dividend payers in March another sign the market is shifting to focus more on value oriented equities versus growth equities? We discussed this potential transition in a post a week and a half ago when we discussed the significance of the recent outperformance of value stocks versus growth stocks.

The market's action today was certainly most negative for the momentum oriented stocks and biotech and social media sectors. On a year to date basis the utility sector has significantly outperformed the overall market as can be seen in the below chart. Utility stocks tend to be safe haven investments for investors due to their generally higher dividend yields.

From The Blog of HORAN Capital Advisors

We would caution investors to pay attention to stock valuations (P/Es) relative to a company's earnings growth rate (PE divided by EPS growth rate) as some of these historically value oriented stocks/sectors are trading at rich valuations and high PEG ratios.