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

Monday, August 11, 2014

Week Ahead Magazine For August 10, 2014

Last week saw the market's trading action gravitate from positive to negative during the week until Friday. The chart to the right shows the daily changes in various market indices with Friday's sharp bounce back. A question for this week will be whether last Friday's trading bounce signals a bottom in the market's recent decline.

Today pre-market futures are indicating a positive start to the trading week. This comes on the heals of positive market performance in global markets on Monday. One article link in the Week Ahead Magazine covers some technical data that is suggestive of a potential market bottom. Additionally, another article notes the decline in investor bullish sentiment, as well as investors continued appetite for bonds. Below is the link to this week's magazine.

Sunday, August 10, 2014

Bond Funds Continue To See Inflows

Last week's mostly negative market, until the sharp recovery on Friday, continues to negatively influence investor's market sentiment. Last week's American Association of Individual Investors reported bullish investor sentiment fell slightly to 30.9%. This bullishness level is nearly nine percentage points below the long term average of 39%.

From The Blog of HORAN Capital Advisors
Source: AAII

An interesting factor reported in the Sentiment Survey was the 7.1% increase in bearish sentiment to 38.2%. Much of the recent commentary seems centered around the fact the market (S&P 500 Index) has not experienced a 10%+ market correction in over 30 months. Factor in the number of geopolitical issues around the globe and the Fed's reduction of QE, it is no wonder investors have a less than favorable view of the market.

Fund flow data seems to be supportive of the fact investors are not overly bullish. The below chart shows fund flow data through June. Every month except for January of this year has seen positive investor flows into bond and income funds. June of this year witnessed the first outflow from equity mutual funds in over a year. This equity fund outflow continued in July as noted in the table following the monthly fund flow chart below.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

In spite of what seems like a near uninterrupted advance in the equity markets since the end of of the Great Recession, fund flow data does not suggest investors have reallocated out of bonds into stocks in any significant way. In looking at the below chart, it seems apparent the cumulative flow of funds into bond and income funds still far out weighs any recent positive flows into equity funds. As noted earlier, and this can be seen on the below chart, positive flows have returned to bond funds this year.

From The Blog of HORAN Capital Advisors

Generally, market tops do not get realized until a capitulation, "all-in" type positive inflow into stocks occurs.

Thursday, August 07, 2014

Currency Adjusted Returns Matter When Investing In Foreign Markets

Almost a year and a half ago the Bank of Japan stated it would embark on a massive stimulus plan, i.e., quantitative easing, that would amount to the equivalent of $107 billion US dollars. Many strategists have taken a positive view of this effort by Japan to stimulate the country's economy. The near term, immediate impact to Japan's stock market at that time, the Nikkei 225 Index, was a dramatic move to the upside. As the below chart shows (two year time frame), the Nikkei was up over 80% from August 2012 through May of 2013 and the S&P 500 Index was up only 20%. However, when the Nikkei returns are converted back to the US Dollar, the Nikkei returns equal about 35%.

From The Blog of HORAN Capital Advisors

Fast forward to the end of 2013 from August 2013 and the Nikkei continued to outperform the S&P 500 Index; however, when converting the Nikkei returns to US Dollars (blue line in the below chart), the Nikkei has underperformed.

From The Blog of HORAN Capital Advisors

Many investors gain exposure to foreign markets via mutual funds or ETFs. For investors then, it is important to understand the currency hedging strategies being employed within a particular fund. If a fund had not been hedging its currency exposure in the Nikkei for a US domiciled investor, returns would have been significantly impaired.

The currency hedging issue has always been important, maybe more so today given central bank interventions. The central bank stimulus programs have resulted in weakening the currency of the central bank's country. In the case of Japan, the weaker YEN (stronger US Dollar) has negatively impacted US Dollar returns.

Also, recent media reports are touting the strong returns in "frontier" markets. For investors, they need to analyze the currency hedging strategy in the fund(s) they intend to invest in. A strong dollar relative to other currencies can significantly reduce any return advantage these non-U.S. markets may generate in their respective home country currency.

Wednesday, August 06, 2014

Why To Invest In Stocks

I wrote an article this past weekend that provided a link to an interview with Jason Trennert conduct by Consuelo Mack of WealthTrack. The theme of the interview and the post is the belief there currently is no alternative for investors other than stocks. My article was republished on Seeking Alpha and a reader responded with several comments and questions. I responded to his questions and the reader thought the response was worthy of an article of its own. Below are the reader's questions/comments and my response.
  1. Why is the shrinking number of listed companies important?
  2. The total market cap is at an all-time high, and the ratio of total market cap to GDP is near an all time high.
  3. Is there any rigorous study that shows that currently low interest rates have a strong correlation with 'future' stock market returns?
The shrinking number of listed companies is important from the standpoint of supply and demand. If demand for stocks remains the same and the supply of available stock declines, then prices will gravitate higher, all else being equal. In the video referenced in my earlier article, I believe Jason Trennert provides pretty good commentary behind the decline in company stock listings. Certainly some companies have gone out of business since the bust. However, Trennert notes an increasing number of companies lack the desire to go public due to the regulatory and legal cost. Some of what is occurring is companies will sell themselves to private equity firms.

From The Blog of HORAN Capital Advisors

Additionally, the current environment has witnessed a pick up in M&A activity and this was cited in a recent report by Jeremy Grantham of GMO as well. The M&A activity results in reducing stock supply. Increased M&A historically is an early, late business cycle activity. Grantham and others believe we are in the middle innings of M&A in this cycle. When public companies deploy excess cash in an acquisition, the balance sheet cash that is earning virtually zero percent interest then results in the acquisition being accretive to corporate earnings.

Regarding interest rate movement and stock prices when rates rise from a low level. JP Morgan has an interesting chart showing when rates rise from a low level, below 5%, stocks have a positive correlation to the direction of the rate move. Intuitively, this might make sense in that the Fed is simply moving rates back to a neutral level in order to have fire power in the event it is needed. When rates are increased at levels above 5%, this is generally a sign the Fed is attempting to slow down the economy. Maybe inflation is beginning to become an issue, tight capacity, higher wage growth, etc. In this situation, the rate rise, when above 5%, likely would result in slowing economic activity and as such slowing earnings growth which then leads to lower stock prices.

From The Blog of HORAN Capital Advisors
Source: JP Morgan GTM
Lastly, regarding equity values and GDP, Scott Grannis of the Calafia Beach Pundit website has a good article discussing this valuation measure. The article is a worthwhile read. In short he notes valuations by this measure are at levels similar to the early 1960s. He notes in the article the early 1960s was an environment "when inflation was low and stable and U.S. interest rates were low and stable, much as they are today." Below is the valuation chart he included in the article.

From The Blog of HORAN Capital Advisors

From a contrarian standpoint, I must say the amount of bearish commentary mentioned over the past several weeks seems to be dominating the headlines. The below chart highlights the increase in Google (GOOGL) search activity for the phrase " stock market correction." Historically, market corrections do not occur when everyone expects them. Having said this, this is a seasonally weak period for equities.
From The Blog of HORAN Capital Advisors
Source: Google Trends

Disclosure: Long GOOGL and GOOG

Monday, August 04, 2014

Massive Bearish Put Volume On Friday May Have Been An Error

Over the weekend we noted the big spike in the put/call ratio to 1.04. Generally, when the put/call ratio exceeds 1.0, from a contrarian perspective, this overly bearish activity can be a positive for stock prices. Was the increased volume an error?

Reuters is reporting the trades could be an error. In the article lead in they note, "A barrage of bearish options contracts costing an estimated $8 million and set to expire worthless in a few hours were purchased across multiple stocks Friday afternoon in a move that traders said made no sense." If these trades are an error, maybe bearish sentiment is not has elevated as the data suggested.

Sunday, August 03, 2014

Dividend Payers Underperformed In July

Much is made by some investment managers that dividend payers hold up well in market downturns. Generally, we would agree that is the case; however, this performance advantage does not always bear out and one must look at the underlying cash flow of individual companies. A case in point is the performance of the payers in July.

As the below table shows the average performance of the payers underperformed the non-payers by almost two full percentage points. On a year to date basis the average return of the payers is also lagging the return for the non-payers. As the below performance table shows, most S&P 500 companies do pay a dividend. The difficulty with the safety trade in July was the fact some of the defensive sectors underperformed the overall S&P 500 Index. The staples sector is one of those defensive sectors and the relative performance versus the S&P 500 Index is noted below as well. In that chart, if the line is declining, the noted sector is underperforming the broader S&P 500 Index.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

One sector that performed well versus the overall S&P 500 Index was technology. At HORAN we do believe this sector continues to offer opportunities for investors.

From The Blog of HORAN Capital Advisors

Week Ahead Magazine: August 3, 2014

With July in the books, investors experienced the negatives of what tends to be a weak seasonal period for the equity markets. The worst performing segment of the U.S. market continued to be the pullback in small company stocks as represented by the Russell 2000 index. Small caps declined 7.3% in July while the larger cap stocks represented by the S&P 500 Index fell 2.8%. Small caps are now down 4.2% year to date while the S&P 500 Index remains higher by 4.2%.

For the most part economic news this past week was positive. Probably the most positive report was the first read on second quarter real GDP that was reported at 4.0%. For many, including us at HORAN Capital Advisors, there seems to have been a bounce back in economic activity from the weakness experienced in the first quarter due to the extreme cold weather conditions across the U.S. at that time. We do expect, however, this snap back was not significant enough to expect this level of growth through the balance of the year. One article in our magazine covers some of the underlying concerns with the recent GDP report.

Lastly, economic reports for the coming week will be relatively light. Additionally, the pace of earnings reports slows with a number of the reports coming from companies less optimistic about growth prospects. As we have noted in several reports on our blog this week, much technical damage was done to the market this past week. The magazine highlights several indicators that indicate the market is at least oversold on a short term basis which could result in a market bounce this week. The key will be whether or not the bounce can carry forward to a continuation of this bull market.

Saturday, August 02, 2014

No Alternative Other Than Stocks

Consuelo Mack of WealthTrack recently interviewed Jason Trennert, Managing Partner and Chief Investment Strategist of Strategas Research Partners. As WealthTrack notes, "Trennert is widely followed by institutional investors in the money management and hedge fund world, and is identified as one of “Wall Street’s Best Minds” by Barron’s."

In the interview, Trennert believes several factors are leaving investors with no investment alternatives other than stocks. Two reasons he cites are one, financial repression, where governments in developed economies institute policies that keep real interest rates at low or negative levels, and two, the reduced supply of publicly traded stocks. This reduced stock supply is evident in one of the charts Jason displayed during his Consuelo Mack interview.

From The Blog of HORAN Capital Advisors
Source: WealthTrack

The full interview is a worthwhile one for investors to spend time watching. The full interview is accessible below.

Equity Put/Call Ratio Spikes To Above 1.0

In our earlier post today we noted the potential oversold conditions in the equity markets. When reviewing other technical data this morning, I was surprised to see the large jump in the CBOE equity put/call ratio on Friday which put the ratio above 1.0. We have noted in prior posts over the years that this sentiment ratio is most predictive of future market direction when the ratio is at extreme levels. In short,
The equity P/C ratio tends to measure the sentiment of the individual investor by dividing put volume by call volume. At the extremes, this particular measure is a contrarian one; hence, P/C ratios above 1.0 signal overly bearish sentiment from the individual investor. This indicator's average over the last 5-years is approximately .625 indicating the individual investor has been generally mostly bullish and more active on the call volume side.
From The Blog of HORAN Capital Advisors

Market Looking Oversold

Both the New York Stock Exchange Index (NYA) and the S&P 500 Index (SPX) are down from their recent highs 3.7% and 3.2%, respectively. Although the magnitude of the declines is not large, the indices are looking oversold. The relative strength index, the MACD indicator and the stochastic indicator are indicating oversold levels as well. It should be noted that the MACD is less useful as an oversold market indicator as it is unbounded. The MACD is most useful in determining market turning points when crossovers occur with the MACD line (green line in bottom pane) and the red signal line.

From The Blog of HORAN Capital Advisors

In looking at the percentage of NYSE stocks trading above their 50 and 150 day moving averages, these two measures are near levels where past market sell offs have bottomed. Certainly, these percentages can go lower.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Thursday, July 31, 2014

Is This The Much Awaited Market Pullback?

Today the S&P 500 Index fell 2% and this takes the Index into negative territory for the month of July: -1.51% on a price only basis. For the year the S&P 500 Index remains in positive territory, up 4.44% on a price only basis. The question for investors is whether this weak July and significant decline on the last day of July is a precursor to further market weakness. Answering the question may be important as a number of investors are waiting to "buy on the dip." Is July, and more importantly, the pullback today "that" dip or is more downside weakness ahead.

Quite a bit of technical damage was inflicted on the market today with the 2% pullback. However, the extent of the pullback, I know only 2%, does put the market close to some technical support. As the below chart shows, the S&P 500 Index is approaching the green support trend line. The support level is about 1,907 or just a little more than 1% below today's close.

From The Blog of HORAN Capital Advisors

Other technical measures have support near this level as well. One technician I follow is Charles Kirk of The Kirk Report. Traders and program trading implement strategies based on these so-called technical setups. As Charles Kirk noted in his after market report tonight, today's action triggered a bearish head and shoulder pattern. The measured move downside target of 1,914 and is near the trend line support level noted in the above chart.

From The Blog of HORAN Capital Advisors

With the end of July now in the books, commentators have turned to the outlook for August. A couple of charts making the rounds over the last few days are noted below. These charts show the historical market performance for both the Dow and S&P during the sixth year of a presidents term. History shows the August to October period as a seasonally weak one.

From The Blog of HORAN Capital Advisors

Ryan Detrick provided some detailed return calculations for the S&P 500 Index that encompassed various time periods. One of the several tables he included in his recent article,  Here Comes August, Get Ready, is noted below. This data also confirms the fact the market has a tendency to be weak in August. This is not a certainty though, as the tables show July is generally positive and this was not the case this year.

From The Blog of HORAN Capital Advisors
Source: Ryan Detrick

Importantly for investors, company fundamentals will drive the long term direction of the markets. By and large, earnings reports have been better than expected. In this regard, Thomson Reuters noted in their S&P 500 earnings update for Q2,
  • "Through July 30, 61% of the S&P 500 companies have reported earnings for Q2 2014. In aggregate the actual earnings growth rate for those 305 companies that have reported earnings is 7.6%. Excluding Citigroup (C), the actual earnings growth rate is 10.2% and the Financials sector actual earnings growth estimate is -0.5%."
  • "The Q2 2014 blended revenue growth rate for the S&P 500 is 3.8%, which is above the 2.3% trailing four quarter average earnings growth. In aggregate the actual revenue growth rate for the S&P 500 companies have reported revenue for Q2 2014 is 5.2%."
From The Blog of HORAN Capital Advisors
Source: Alpha Now

What was a bit odd about today's ending results for the market was the fact nearly every investment category was negative. Even the safety trade of U.S. treasuries lost ground as the yield rose to 2.56%.

Yes, there are some worrisome issues facing the market: the Argentina default, a banking issue in Portugal, the Ukraine/Russia conflict, the Middle East conflict, etc. Investors should keep in mind the short impact crisis events tend to have on the equity markets. We discussed this again in a June post, Crisis Impact On Markets.

The market is entering a seasonally weak period for sure; however, company and economic fundamentals remain intact in our view. We do not believe the economy is sustainably growing at 4% as noted in the first read on GDP earlier this week nor do we believe it is contracting. The earlier chart in this post that graphed the returns in the sixth year of a president's term, on average, had the market down about 6% during the July-October period. After today, the S&P is down about 3% from its high. Could the market decline another 3-7% to give us the much awaited 10% correction? Certainly. Market bottoms are hard to time though.

As a final technical note, Charles Kirk also commented on the potential for a positive trading day on the first day of August.
"there is a very strong tendency to see a bullish first of the month jumper trade when the last day of the month is this negative. In addition, the market has also tended to trade higher on jobs report days (19 of last 24)..."
The night is long, but Thursday night futures are indicating a positive bias to Friday trading at this point.

From The Blog of HORAN Capital Advisors
Source: Bloomberg