Sunday, August 20, 2017

Dr. KOSPI's Protocol For Global Growth Diagnosis

It has been about two weeks and market sentiment seems to have quickly turned decidedly bearish and the S&P 500 Index is down only 2.2% from its high. I will not list all the bearish commentary over the last few days, but we even pushed out some thoughts this weekend on our Twitter account (@HORANCapitalAdv) that leaned a little bearish. A couple of reasons for the increased bearishness might be the fact the market has gone over a year without a pullback of more than 5% and stock valuations do appear elevated on an absolute basis. Lastly, with the increase in technical and computerized trading, readers should know the S&P 500 Index acquired a significant target price that was triggered over four years ago and was formed out of a 16 year trading range for the market. Once significant levels like this are reached, it is not uncommon for the market to at least consolidate gains.


So enough of the bearishness, what might the market be projecting now. One index that has a fairly good track record of providing a clue to other market moves is the KOSPI Index, or the Korea Stock Exchange Index. This index is frequently referred to as Dr. KOSPI, partially due to the fact it leads or takes care of the other indices. Noted economist, Ed Hyman of Evercore ISI, beleives the KOSPI index is a leading indicator of the global economy as South Korea's exports account for over 40% of the country's gross domestic product. In other words, the KOSPI Index performance is a reflection of the health of the global economy. Over time, the KOSPI Index returns tend to lead the performance of the S&P 500 Index. Some of the history is displayed in the below chart.


What can be seen in the first section of the above chart is the KOSPI Index (blue line) begins to trend down in advance of the S&P prior to the tech bubble and real estate crisis. The KOSPI also turned lower in advance of the debt ceiling crisis in the U.S. in August of 2011 and the U.S. credit downgrade.

The next chart shows G7 Industrial production around periods in which the KOPSI turned lower in advance of U.S market turning points. The dotted lines are at the same time period as in the above chart. The contraction in industrial production tended to occur within about six months following declines in the KOSPI Index.


So where does that leave the market potentially positioned today. The below chart represents a shorter time frame of the earlier KOSPI/S&P chart. What is clear from the chart is the KOSPI began to weaken in July, in large part on concerns with North Korea in my view. The last week or so has seen a rebound in the KOSPI at a time the S&P 500 Index continues its move lower though.


I would surmise Dr. Kospi's market diagnosis at the moment is one of cautious optimism. We are in a seasonally week period as it relates to the calendar, i.e., summer, the market has not had a pullback of 5% or more in more than a year, valuations are above their long term average and last week's industrial production report was positive but below expectations. On the other hand, market commentary has turned more bearish in a short period of time. From a contrarian standpoint, the market does not tend to reward investors who are correctly positioned for a correction. If recent bearishness is a sign of actual investor positioning, a market that moves higher is likely after a bit more summer weakness, i.e., a market that climbs the proverbial wall of worry.


Friday, August 18, 2017

No Slowdown In Growth Of e-Commerce Sales

It seems nearly every company reporting earnings now references a strategy to deal with Amazon (AMZN) due to Amazon's command of e-commerce sales. Beyond the simple delivery of packages and hard goods, AMZN is moving into many other areas like grocery, air transportation, etc. I discussed this in a post a few months ago. In that post I highlighted the profitability of Amazon's cloud business (AWS) and the company using AWS profits to fund growth in other industries.

Yesterday, the U.S. Census Bureau reported quarterly retail e-commerce sales for the second quarter of 2017. Not a surprise to many now, e-commerce sales continue to grow at a high rate, i.e., up 16.2% on a year over year basis for Q2. Traditional brick and mortar sales were up a small 2.9% year over year. The other notable highlight from the Census Bureau report, e-commerce sales now account for 8.9% of total retail sales. This is nearly three times larger than ten years ago.


Finally, due to the success of e-commerce broadly, many of the related stocks have been pushed to valuation levels far above the market's valuation. As the below chart shows a quick price run up can just as quickly turn in to a price decline. Are these e-commerce equities setting up investors for disappointment?


Certainly, valuations can become more stretched and these stocks can move higher for an extended period of time; however, investors with outsized positions in this industry should evaluate their overall exposure relative to their entire investment portfolio.


The Economy May Not Be At Full Employment

One economic conundrum has been the sub-par growth rate in average hourly earnings in spite of what appears to be an economy operating at full employment. In a fully employed economic environment, wages generally see fairly strong upside pressure and this becomes a concern with the Federal Reserve due to the upward pressure placed on the inflation rate. As the below chart does show, average hourly wages have grown at about a 2% annual rate since the end of the financial crisis. Prior to the onset of the last recession, wage growth was in the range of 3% to 4%. From a positive perspective though, wages have been growing faster than the rate of inflation for most of the last four years. Additionally, the differential wage growth and inflation in this cycle is on par with prior economic expansions.



Sunday, August 06, 2017

Investor Fund Flows Favoring Bonds And Not Equities

The equity market has gone over a year without a pullback of at least 5% or more. The last 5% decline occurred in mid-June 2016 when, over a two week period, the market fell 5.5%. Even in the run up to the election last year, the equity market did not close down over 5%. This lack of volatility is showing up in popular volatility measures like the VIX, but the VIX may not be a good measure of expected future volatility.  Also, this lower level of volatility has some strategists suggesting investor's have become to complacent about the equity market and have willingly taken on more equity exposure as a result.

A recent post by Dr. Ed Yardeni, Ph.D., and he puts out some great research, noted individual investors may have become too optimistic as well. In that post, Investors Hearing Call of the Wild, he included the below chart of U.S. equity ETF flows.



Saturday, August 05, 2017

The S&P 500 Index Is Expensive And Has Mostly Been So Since The Early 1990's

One can cite any number of stock valuation measures and conclude U.S. equities look expensive or are at least trading above their long term average valuation measures. In this environment one might conclude stocks are priced for perfection with little margin for error. Of course this might certainly be the case, but is this an uncommon position for the equity market? As the shaded areas in the below chart show, investors would have had a difficult time buying or holding onto stocks at valuation levels that were below their long term average valuation since the early 1990s.



Tuesday, August 01, 2017

Dividend Payers Are Underperforming

A year ago dividend paying stocks were significantly outperforming the non payers in the S&P 500 Index and the S&P 500 Index itself. If investors were chasing performance back then and loading up on the payers, today they would be disappointed. Below is a chart of the year to date performance of two dividend paying exchange traded funds, SPDR Dividend ETF (SDY) and iShares Select Dividend ETF (DVY). The return of the dividend focused ETFs is nearly half that of the S&P 500 Index.  The return difference is similar for one year. My year ago post contains some details on both ETFs.


Below is S&P Dow Jones Indices' average return summary for the payers and non-payers in the S&P 500 Index as of July 31. The return difference is not as large as noted above due to ETF construction differences, for example, not using all 420 dividend paying stocks in the S&P 500 Index.


The fact the dividend payers are underperforming the non-payers as well as the broader S&P 500 Index itself, seems to be further confirmation of investors seeming to favor growth oriented stocks over value ones. 


Sunday, July 30, 2017

Equity Valuations No Longer Matter?

One benefit to writing blog content is it serves as a record of ones past thinking and the results of any decisions made from the prior analysis. With that in mind I reviewed some of the topics written over a year ago, that is, in June/July of 2016. A few of the topics at that time had to do with valuations, PEG ratios and the fact the market was trading at an all time record high. In fact one article was titled, Is It Right To Be Bullish Near A Record Market High? The conclusion at that time was to stay invested in equities as I wrote then,


Saturday, July 22, 2017

Strong Earnings Growth And Favorable Valuations Lead To Weak Stock Returns

One factor utilized in uncovering potential investment opportunities is to evaluate companies and sectors that are projected to generate strong earnings and cash flow growth over the course of the next year or more. The risk associated with simply reviewing earnings growth rates is the fact other variables often influence the future price performance of a company's stock. A good case in point at the moment can be found in evaluating energy companies and the associated sector. For calendar year 2017 and 2018, the energy sector is expected to exhibit the highest earnings growth rate among all the S&P 500 sectors. For 2017 the year over year earnings growth rate for the energy sector is estimated to equal over 300%. In 2018 the YOY growth rate is projected to equal 41.3%.


Even reviewing the sector PEG ratios (P/E to earnings growth rate), the energy sector looks very attractive and is the only sector that has a PEG below 1.0.


Thursday, July 20, 2017

Jump In Investor Bullish Sentiment But Remains Below Long Run Average

Today the American Association of Individual Investors released their Sentiment Survey results for the week ending 7/19/2017. These results show individual investors' bullish sentiment increased 7.3 percentage points to 35.5%. This is the highest reading since early May when bullish sentiment was reported at 38.1%. This jump in bullish sentiment still has the level below the long run average of 38.5%. The increase in the bullish reading came almost equally from a reduction in those investors indicating they were bearish and those reporting a neutral view of the markets.

This is a contrarian measure and remains at a fairly low level. On the other hand, the market continues to achieve record highs with very little downside volatility. A pullback of 5-10% would not be a surprise given the market's recent strength.

Source: AAII


Wednesday, July 05, 2017

Summer 2017 Investor Letter

Our Summer 2017 Investor Letter reviews the strong equity market performance thus far in 2017.  As of quarter end, the S&P 500 is up 9.34%, the Nasdaq is up 14.07%, and the MSCI EAFE Index is up 14.23% year to date. As investors become increasingly worried about the first significant market decline since early 2016, stocks continue to climb the proverbial “wall of worry.”


For more of our thoughts on everything from the FANGs to the Fed, see our Investor Letter available at the below link:


Monday, June 26, 2017

Market Pullbacks Should Be Expected

There have been plenty of reasons to sell stocks since the end of the financial crisis in 2008. The drumbeat seems to be getting louder as the postwar market advance approaches one of the longest on record.


Also contributing to some angst about the market's advance is the fact the last pullback/correction of greater than 10% occurred in February 2016. In other words the market has gone more than 16 months without a >10% pullback. As the below chart shows, market pullbacks of nearly 10% are a fairly common occurrence. The market's average intra-year decline equals 14.9%.