Thursday, March 26, 2015

Strong Buyback Activity Reducing Share Count

S&P Dow Jones Indices is reporting that stock buybacks fell sequentially in the fourth quarter last year to $132.6 billion from the third quarter level of  $145.2 billion. However, on a year over year basis, buybacks increased by 2.5%. this still strong buyback activity has served as a tailwind for earnings growth as the report notes 20% of the S&P 500 companies have reduced their share count. Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices notes, "...While fourth quarter expenditures were down 8.7%, the number of issues reducing their share count by at least 4% year-over-year, and therefore increasing their EPS by at least that amount, continues to be in the 20% area – a significant level." Other key metrics noted in the report:
  • "More issues reduced their share count this quarter than last, with 308 doing so in Q4, up from 257 in Q3 and 276 in Q4 2013."
  • "Significant changes (generally considered 1% or greater for the quarter) continued to strongly favor reductions, and also increased, as 117 issues reduced their share count by at least 1%, compared to last quarter’s 101 and the 112 which did so in Q4 2013."
  • "Share reduction change impacts of at least 4% (Q4 2014 over Q4 2013), which can be seen in EPS comparisons, were flat at 99 in Q4 2014 from Q3, but up from the 83 posted in Q4 2013."
Although the earnings growth trend appears to be slowing, cash generation continues to be strong for companies. Silverblatt notes with banks now appearing to focus on dividends and buybacks, 2015 could witness another strong year for dividends and buybacks for the S&P 500 Index.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Data Source: S&P Dow Jones Indices

Thursday, March 19, 2015

Bullish Sentiment Declines To Level Last Seen In Early 2013

This morning the American Association of Individual Investors reported individual investor bullish sentiment declined to 27.2% versus last week's reading of 31.6%. This is the lowest level for bullish investor sentiment since April 4, 2013. Additionally, today's report places the sentiment reading at one standard deviation below the average sentiment level. The decline in sentiment over the past week is proving its status as a contrarian indicator as the S&P 500 Index is higher by 2.9%.

From The Blog of HORAN Capital Advisors
Source: AAII

Saturday, March 14, 2015

Bearish Equity Sentiment Showing Up In The Equity Put/Call Ratio

As we noted Thursday, the American Association of Individual Investors reported a further decline in its bullish sentiment reading. The reported level of 31.6% is near a level indicative of overly bearish investor sentiment. Further confirmation of this bearish sentiment is seen in Friday's equity put/call ratio which is reported at .80. As with the AAII bullish sentiment reading,  the equity put/call ratio is most predictive at extreme levels or above 1.0. Nonetheless, overly bearish investor sentiment is suggestive of a near term equity market bounce.

From The Blog of HORAN Capital Advisors

Thursday, March 12, 2015

Investors Less Bullish As Market Nears Oversold Level

The American Association of Individual Investors reported an 8.2 percentage point decline in bullish investor sentiment to 31.6% this morning. This is the lowest bullishness level since bullish sentiment was reported at 30.89% in early August of 2014.

From The Blog of HORAN Capital Advisors
Source: AAII

This decline in bullish sentiment has occurred at a time when the S&P 500 Index appears to be nearing an oversold level. As the below chart shows, the technical stochastic indicator has fallen to an oversold level. The money flow indicator and MACD indicator have yet to confirm an oversold level; however, the market does appear to be nearing a potential bounce level. In the recent past the 150 day moving average has served as a support level for the S&P 500 Index and it will be important that this level (2017) is held in this recent pullback.

From The Blog of HORAN Capital Advisors

Sunday, March 08, 2015

Additional P/E Multiple Expansion Possible Until The First Fed Rate Hike

A common occurrence in equity bull market cycles is the fact that a company's valuation, or P/E multiple, expands. This so called multiple expansion is one factor that contributes to overall equity returns during bull market phases. The downside to multiple expansion is it does not occur ad infinitum. As the below chart shows, the P/E multiple for the S&P 500 Index has expanded by 64% by increasing to 17.3x earnings versus 10.6x earnings at the start of the current bull market.

From The Blog of HORAN Capital Advisors

One factor that will cause multiple expansion to come to an end, and ultimately revert to contraction, is an increase in interest rates. The reason for this is investors will value future earnings less when a higher discount rate is used to value those earnings in equity valuation models.

The market took Friday's job report as another sign the Fed is nearing a time where it will increase short term interest rates. The job report showed 295,000 jobs were generated in February. The report also noted the unemployment rate declined to 5.5%, which is the lowest level since May 2008. One data point that continues to generate differing points of view is the labor force participation rate. This part of the report noted the participation rate fell slightly to 62.8% from 62.9%. Many market strategists are viewing the jobs report as another sign the Fed is nearing an end to easy monetary policy and a rate hike in June or at the latest by the end of summer.

So with a rate hike nearing, will market forces result in a P/E multiple that begins to contract? Historical data shows; however, market multiples have broadly expanded up until the time of the first rate increase. A report by Sam Stovall, U.S. Equity Strategist for S&P Capital IQ, notes, "After examining the 16 times since 1946 that the Federal Reserve started a rate tightening program, the median multiple on trailing 12-month GAAP (or “As Reported”) EPS rose from 17.7X six months before to 17.9X three months before and 18.5X on the date of the first rate increase. Only in the three and six months after the Fed started raising rates did the P/E median decline to 18.1X and 16.7X, respectively." In a recent report from Goldman Sachs, they include a table comparing S&P 500 returns along with the impact on valuations before and after Fed rate increases. As can be seen in the below table, P/E multiples and returns are positive up to the first rate increase.

From The Blog of HORAN Capital Advisors

Also, given the near zero level of interest rates along with the low level of inflation, equity valuations are not as stretch as they may appear in nominal terms.

From The Blog of HORAN Capital Advisors

The Fed does appear to be in a position where an interest rate increase is likely to occur this year. One could surmise the Fed is in a position where they need to get rates back to a more normalized level. At this near zero interest rate level, the Fed has fewer monetary options to implement in the event an economic shock where to occur. Additionally, because rates are at artificially low levels, history has shown there is a positive correlation between stock prices and interest rates when rates rise from levels below 5%.

From The Blog of HORAN Capital Advisors

A part of the reason for this is when rates are at such extreme lows, initial rate increases are instituted simply to get rates back to a more normal level. When rate increases occur at levels higher than 5%, this can be a sign of an overheating economy with the Fed's intention to slow down the economy. As the economy slows, corporate earnings are likely to slow, resulting in equity prices declining as well.

For investors then, as a rate hike does seem near,  positive equity market returns can be achieved up until the time the first rate increase occurs. Also, a portion of the returns can be generated from a continued expansion of P/E multiples.

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.