Sunday, July 20, 2014

Week Ahead Magazine: July 20, 2014

This past week was an event filled one as geopolitical concerns rose to the top of investor worries with issues in Ukraine. As Josh Brown noted in an article he posted last week, these geopolitical events seem to be ever present. He noted though, the change this past week was investor awareness became focused on these concerns with the downing of the Malaysian airliner over Ukraine. In spite of this type of headlines news, the S&P 500 Index manged to generate a positive return of .54% for the week. The small cap segment of the market continues to face headwinds and was down .72% last week.

From The Blog of HORAN Capital Advisors
Source: Doug Short

In the coming week, earnings season begins to pick up pace with a number of companies reporting. As noted by Brian Gilmartin, CFA, of Trinity Asset Management, "Factset notes that with 82 of the SP 500 companies having reported, the “revenue beat rate” of 70% quarter-to-date is at a record high. That would be a significant change to the quarterly patterns if its holds up through the end of July and mid-August, 2014. This improvement in revenue growth could have important implications for stock prices if the revenue growth is realized in the balance of the year. Additionally, key economic stats reported this week are:
  • Consumer Price Index (T)
  • Jobless Claims, New Home Sales (Th)
  • Durable Goods (F)
In all, the market does not seem to want to put in a meaningful correction. A correction will occur though and most likely at a time that is least expected. Below is the link to this week's magazine.

Thursday, July 17, 2014

Investor Letter Summer 2014: A Near Perfect Quarter For Equity Returns

HORAN Capital Advisors has released its Summer 2014 Investor Letter. The markets have seen synchronized returns in 2014 with almost all major equity classes generating positive returns. Many investors are questioning the ability of the equity markets to display continued strength in light of not having a 10+% correction in over two years. The economy was very weak in the first quarter as measured by the final GDP number, which showed the economy contracting at a 2.9% annual rate. Yet, we believe the first quarter weakness can be mostly related to the extreme winter weather across much of the U.S. The magnitude of the decline surprised many economic forecasters with weakness in the GDP report largely attributable to a weaker inventory build. Our investor letter discuss our views on interest rates as well as economic and corporate financial fundamentals for the balance of 2014.

From The Blog of HORAN Capital Advisors

Sunday, July 13, 2014

Week Ahead Magazine: July 13, 2014

Much of the blame for the slight weakness in U.S equity markets and more significant weakness internationally is being attributed to a weak industrial production report out of Germany, minus 1.8% for May, and concerns about about systemic risks to peripheral Eurozone lenders after Portugal's regulatory agency suspended trading in Banco EspĂ­rito Santo Thursday. Market's like Spain and Italy were down over 4% with Germany down 3.4%.

The U.S markets seemed to act as though these foreign issues are isolated events. Except for the 4% decline in the Russell 2000 small cap index, the broader S&P 500 Index and Dow Jones Industrial Average were down less than 1% on the week.

From The Blog of HORAN Capital Advisors
From The Blog of HORAN Capital Advisors

For the week ahead, several important economic reports will be released:
  • Retail Sales (T)
  • Producer Price Index and Industrial Production (W)
  • Housing Starts, Jobless Claims and Philly Fed Survey (Th)
  • Consumer Sentiment and Leading Indicators (F)
Also important this week will be a number of earnings reports from financial firms like, Citigroup (C), Goldman Sachs (GS), JP Morgan (JPM). In the technology sector, Intel (INTC), Google (GOOG), and International Busness Machines (IBM) report earnings as well.

Article links readers may find of interest can be found in this week's magazine below:

Disclosure: Long JPM, INTC, GOOG

Looking For Data To Support A Market Correction

Posting commentary has been light this past week for a number of reasons; however, topic thoughts often come from interesting articles I read throughout the week. The difficulty of late has to do with the abundant stream of commentary that is predicting the end of this bull market run, i.e., the dreaded 10+% correction which has not been experienced for over two years now.

From The Blog of HORAN Capital Advisors

Exacerbating this stream of thought has been the media's effort to stoke fear in investors' minds. This past week CNBC has used its yellow highlight of market indicators to indicate big market down days, yet, on the week, the S&P 500 Index was down only .9%. Given the level of the S&P 500 Index and the Dow Jones Industrial Average, triple digit point declines for the DJIA do not necessarily translate into large percentage declines. I suppose someone will figure out the math behind that eventually.

Avondale Asset Management's Chief Investment Officer posted an article early last week noting that the current bull market run in the S&P 500 Index without a 10% correction is the sixth longest ever. As the below chart shows, this bull market run of 25 months can certainly continue for many more months.

From The Blog of HORAN Capital Advisors

So having commented on the 10% correction fear, is there current data that would be predictive of a market correction. Knowing the economy is not the market, but what does the economic data suggest? Below is a chart dump of some important economic variables and all of them indicate economic strength.  I will say though, the economic data is not supportive of a robust economy, but more of a bump along slow growth one. I will not go into the significance of each one; however, interested readers can read about these indicators in a post we wrote in December of 2009, Key Economic Indicators Suggest The Worst Is Behind Us.

Jobless Claims:

From The Blog of HORAN Capital Advisors

Retail Sales:

From The Blog of HORAN Capital Advisors

Consumer Sentiment:

From The Blog of HORAN Capital Advisors

Existing Home Sales:

From The Blog of HORAN Capital Advisors

Durable Goods New Orders:

From The Blog of HORAN Capital Advisors

Leading Index Indicator:

From The Blog of HORAN Capital Advisors

Capacity Utilization:

From The Blog of HORAN Capital Advisors

TED Spread:

From The Blog of HORAN Capital Advisors

We discussed several other factors in a post earlier this month, What Event Triggers The Next Market Correction, where we noted the improving trend in negative/positive earnings preannouncements, an improving trend in forward earnings growth, underlying strength in the U.S. Manufacturing PMI. As an update on the earnings front, Factset is showing a mostly improving estimated earnings growth trend for the Q2 2014 time period. This improving trend has been in place since Q3 2013.

From The Blog of HORAN Capital Advisors
Source: Factset

And is the market maybe ahead of where earnings suggest it should be? Maybe somewhat. We do believe the market's valuation is slightly above its long-term valuation average, but not wildly overvalued. Additionally, we do know the market does not correct simply because it might be overvalued.

From The Blog of HORAN Capital Advisors
Source: Factset

Are there things investors should be concerned about? Yes. One is the fact the market will correct. Now is the time to review one's asset allocation and reallocate investments from overweighted positions or categories into underallocated ones. Everything around the globe is not a utopia, there are issues in Ukraine, the Middle East and Portugal, just to name a few.

The market does like to climb the proverbial wall of worry. Market stats, like the absence of a 10% correction, are certainly interesting factors to evaluate; however, at the end of the day, "anticipated" economic and corporate fundamentals are important factors to analyze. As Investment Analyst Andrew Thrasher noted in a recent article, Market Stats, Fun Facts, and Why You Can Ignore Them, some of the technical stats are interesting, but investors should use caution in basing their entire market bias on them.

Sunday, July 06, 2014

Week Ahead Magazine: July 6, 2014

The major U.S. equity indices ended the shortened holiday week last week in the green. The best performing index was The Nasdaq Composite up 2.0%, with the worst performer being the S&P 500 Index up 1.2%. A notably weak sector was utilities (XLU) down over 3%. Consumer discretionary (XLY), health care (XLV) and technology (XLK) were the  top performing sectors. Some credit the strength in the equity market to the generally positive economic reports last week. Officially, earnings season kicks off this week with Alcoa's (AA) report after the market close on Tuesday.

Econoday sums up the reports fairly well by noting,
"For the second quarter, the recovery has regained strength across a variety of sectors. Clearly, the consumer and manufacturing sectors are gaining strength. However, construction is uncertain. But the latest and positive employment data suggest that there may be better numbers ahead at least for housing. Second quarter GDP growth should be relatively strong."

Following is the link to this week's magazine.

Friday, July 04, 2014

Dividend Payers Lose Ground In June And A Review Of Equal Weight Strength

During the month of June the capitalization weighted S&P 500 Index was up 2.07%. The equal weight Guggenheim Index (RSP) returned 2.86%. This equal weight outperformance was also achieved by both the dividend payers and non payers in the S&P 500 Index. In total though it was the non payers that outperformed the payers during June by returning 3.91% versus the payers return of 2.56%. For the last twelve months though, the dividend payers maintain a performance advantage over the non payers, 34.11% versus 32.26%, respectively.

From HORAN Capital Advisors

This equal weighted outperformance of the payers and non payers over the S&P 500 Index is a phenomenon that is occurring on a longer term basis in the broader equal weighted index as well. As the below chart shows, over the last year the Guggenheim Equal Weight S&P 500 Index (RSP) is outperforming the S&P 500 Index. We discussed this positive equal weight trend in a post last month, Active Share And Equal Weighted Investment Strategies.

From HORAN Capital Advisors

Wednesday, July 02, 2014

What Event Triggers The Next Market Correction

There is no one variable or silver bullet that will provide insight into the future direction of the stock market or an individual stock. At the end of the day though, a stock's future direction will depend on a company's ability to grow its earnings. We constantly review data, financial and economic, that will provide insight into earnings growth for companies, the overall market and specific countries.

With the strength of the markets' advance since the end of the Great Recession, and this improvement seems to be occurring globally as we noted in an earlier post on first half 2014 returns, the question most frequently ask is what derails this uptrend. Aside from the unpredictable black swan type of event, a slowing of growth in corporate earnings on a broad based basis would certainly be a catalyst for an equity market correction. Below are a few earnings related data points that would seem to suggest companies are continuing to see growth though and this growth is occurring at a slowly increasing rate.

First, earnings for S&P 500 companies have seen a sharp and fast recovery since the middle of 2009. Recent commentary from the Chart of the Day chart service noted,
"With earnings season just around the corner, today's chart provides some long-term perspective on the current earnings environment by focusing on 12-month, as reported S&P 500 earnings. Today's chart illustrates how earnings declined over 92% from its Q3 2007 peak to Q1 2009 low which brought inflation-adjusted earnings to near Great Depression lows. Since its Q1 2009 low, S&P 500 earnings have surged to all-time record highs. To further illustrate the significance of the current corporate earnings recovery, consider that the run-up in real earnings from Great Depression lows to credit bubble peak took over 74 years. The run-up from financial crisis lows to today has been similar in magnitude (actually slightly more) but was accomplished in a mere five years. In the end, S&P 500 earnings are currently at all-time record highs."
From HORAN Capital Advisors

The positive earnings result displayed above is history though. More important is forward  earnings growth and we can look at earnings guidance. On that front forward earnings expectations are improving. The below chart notes the severe earnings contraction during the financial crisis and the strong recovery into 2010. More importantly is the IBES forward earnings expectations since mid 2012. The earnings growth estimates since that time have been on a steady uptrend with a 12-month forward expected earnings growth of 7.42%.

From HORAN Capital Advisors

With the end of the second quarter occurring on Monday, attention will be focused on upcoming second quarter earnings reports. In that regard, Factset Research noted in a recent report the trend in earnings guidance from companies themselves has moved in a more favorable direction. One highlight from Factset's Guidance report notes,
"Since hitting a peak in negative EPS guidance in Q4 2013, companies in the S&P 500 have issued fewer negative EPS preannouncements and more positive EPS preannouncements for the second consecutive quarter. For Q2 2014, 84 companies have issued negative EPS guidance and 27 companies have issued positive EPS guidance. The number of negative preannouncements is below the record high of 95 set in Q4 2013, and the number of positive preannouncements is above the record low of 17 also set in Q4 2013. If these are the final numbers for the quarter, it will mark the lowest number of negative EPS preannouncements since Q4 2012 (79) and the highest number of positive preannouncements since Q4 2012 (34). (emphasis added)"
From HORAN Capital Advisors

Lastly, this positive earnings trend is not sustainable in a weakening economic environment. Last week's -2.9% GDP report certainly falls in the contraction category. However, at this point in time we do believe the first quarter weakness can partially be blamed on the severe winter experienced across most of the United States. Without fail, I would say in conversations with some of our corporate clients they have indicated they are experiencing a fairly robust business climate going into the summer and into next year. Although the ISM Manufacturing Index was below consensus by .3 points, Econoday noted,
"New orders, as they are in Markit's manufacturing report released earlier this morning, are the key highlight of the ISM report for June, overshadowing the headline composite index which held steady at 55.3. New orders rose 2.0 points to a very strong 58.9 which point to acceleration for general activity in the months ahead (emphasis added). Production, at 60.0, is already very strong as are imports, at 57.0 for a 2.5 point gain."
Below is a table outlining the various categories of the Markit PMI report and notable is the fact most of the categories are expanding.

From HORAN Capital Advisors
Source: Markit and The Kirk Report

Much attention will be focused on the non farm payroll report and the Jobless Claims report, both released before the market open Thursday. The ADP employment report released today noted payrolls came in at 281,000, far above the consensus 213,000. Beyond the fact an improving employment market is needed, growth in jobs has large positive implications for economic growth.

Certainly this market will not continue to move higher in a straight line, although it seems to want to do so. In an article by Dragonfly Capital titled, The SPY Is NOT Extended and May NEVER Pull Back, the author provides "technical" data that suggests the market is not overbought. From a contrarian standpoint, the more articles I see of this nature, the more I sense a pullback or correction is closer to occurring than not. A correction will occur and the timing is not predictable. However, if a correction does occur, fundamentally, the economy does seem to be growing, albeit below its long term potential, and this would be an environment that is still supportive of longer term positive equity returns.

Monday, June 30, 2014

A Rising Tide Lifts All Markets In The First Half Of 2014

With the close of trading today, the first half of 2014 is now in the books. The months seem to click by more quickly each year. As the below index return chart shows, the indices displayed all have relatively healthy returns except for the lagging small cap index. The return data was obtained from S&P Dow Jones Indices and their report had very few negative returns for the indices they reported on. While many investors were and remain under weighted in international stocks, those markets had respectable returns as well.

From HORAN Capital Advisors

From a sector standpoint consumer discretionary stocks were the laggards while the energy and utilities sectors generated strong first half returns. The utilities strength can be attributed partly to the decline in interest rates since the start of the year as utilities are viewed as bond proxies by some investors. The 10-year treasury rate began the year just over 3.0% and closed today at 2.5%. As rates decline the price rises. Investors should keep in mind though, utilities really are not bond proxies as they will act like equity in an equity market correction.

From HORAN Capital Advisors

Our upcoming summer newsletter will cover a more in depth discussion about the second quarter, and more importantly, our thoughts for the second half of 2014.

An Investor's Time Frame Should Weigh Heavily On Expected Returns

I wrote a post a few days ago that highlighted the 10-year annualized returns for the U.S stock market and the MSCI World Index. The summary of the article and the chart was the 10-year annualized market returns remain below their long term averages. A number of our articles are published on SeekingAlpha as was the one just mentioned. One comment to the SeekingAlpha article raised the question that the real returns may display a different result. In short though, the real versus nominal returns, on a ten year time frame, were not vastly different as can be seen in the below chart.

From The Blog of HORAN Capital Advisors

I believe a part of what has investors concerned about the current market at this time is the strength of the market's recovery since the depth of the financial crisis in 2008 and 2009. Additionally, the recent market advance has occurred nearly on an uninterrupted basis, i.e., without a significant correction. The strength of the recent market move is evident in the below chart that looks at the 5 year annualized return for the S&P 500 Index going back to 1926. On this shorter time frame, the rolling 5 year annualized return is far above the average of all the five year returns.

From The Blog of HORAN Capital Advisors

Certainly important economic data released recently raises questions about the sustainability of the current economic recovery. As cliche as it may be, we to believe the weather experienced across the U.S. in the first quarter of 2014 was a major contributor to the weaker GDP report released last week. In the event we are wrong about the weather influence in Q1 reports, as an investor, if you have a longer term time horizon, the 10-year chart would suggest the market is in for further highs on this ten year time frame. For investors with a shorter time horizon, an equity market pullback should not be a surprising occurrence; therefore, a expectations should be set accordingly. To this point though, and as we highlighted in one of our weekend magazine articles by Aswath Damodaran, Ph.D, a Professor of Finance at the Stern School of Business at New York University,he wrote an article about market valuation and concluded market timing can be a difficult endeavor.

Sunday, June 29, 2014

Week Ahead Magazine: June 29, 2014

After a much worse than expected final GDP report last week, the upcoming shortened trading week will be filled with potential market moving economic news. With the markets closed on Friday, Thursday morning investors will receive both the employment report and the jobless claims report. Both of these reports have marketing moving potential. Other key reports this week:
  • Chicago PMI and Pending Home Sales (M)
  • Manufacturing PMI, ISM Manufacturing Index and Construction Spending (T)
  • ADP Employment Report and Factory Orders (W)
  • Employment Situation Report, Jobless Claims and International Trade (Th)
One interesting article contained in this week's magazine was written by Aswath Damodaran, Ph.D, a Professor of Finance at the Stern School of Business at New York University. The article, Bubble, Bubble, Toil and Trouble: The Costs and Benefits of Market Timing, provides detail around using financial metrics to determine whether the market is in a bubble or not. One of his conclusions,
"On a personal note, I have never found a metric or metrics that allow me to have the combination of conviction that a bubble exists, that the correction will be large enough and/or that the correction will happen within a reasonable time frame, to be a market timer. Hence, I don't try! You may have a better metric than I do and if it yields more conclusive results than mine, you should be a market timer."
So, as the holiday trading week begins enjoy some article links in this week's magazine below.

Saturday, June 28, 2014

Gasoline Pump Prices May Be Key To Sustainable Economic Growth

For those that drive a car, they are certainly feeling the effects of higher gasoline pump prices versus four or five years ago. As the below chart shows, however, average gasoline pump prices have been on the decline (barely) since the beginning of 2011. This attempted decline, or at least stabilization, is occurring in an environment where the price of a barrel of crude oil is trending higher. The significance of oil price inflation is the fact only one recession was not preceded by, or coincident with a rise in oil prices. We highlighted the significance of oil prices in our post, Signs Are Not Pointing To A Double Dip Recession Yet, in July of 2010.

From The Blog of HORAN Capital Advisors

Since 2008 the pump price that seems to be one that can trip up the equity market is around $4.00 per gallon as is evident in the below chart.

From The Blog of HORAN Capital Advisors

Although pump prices have been volatile since 2011, the per gallon price trend does appear to be moving lower. As politicians on both sides of the aisle so often do, they cannot resist raising taxes. Just about a week ago a bipartisan Senate proposal is recommending raising the federal gasoline tax by 12 cents and indexing it to inflation. With the $4.00 level being a critical one, this proposal seems like one that could tip the scale of the economy towards a recession for sure.

Lastly, higher gas prices do impact retail sales. If one looks carefully at the below chart, as the price of a gallon of gas has neared $4.00 per gallon, retail sales seemed to spike dip lower. With consumers accounting for 70% of GDP or the economy, a higher gas tax does not seem to be a sound policy decision at this point in time in my view.

From The Blog of HORAN Capital Advisors

10-Year Annualized Equity Returns Remain Below Average

Franklin Templeton Investments published recent commentary on their positive view of equities both in the U.S. and in Europe. The entire article is a worthwhile read; however, one chart included in the write up was the one below showing 10-year annualized returns going back to 1825. As the chart shows, in spite of the strong bull market in equities around the world send the bottoming of the financial crisis in 2009, the compounded 10-year annualized return remains pretty far below average.

From The Blog of HORAN Capital Advisors

The market's recovery since the end of the financial crisis seems to have occurred almost without any significant pullback. As the above chart shows though, a pullback or correction would not be an uncommon occurrence. However, timing the market is difficult and technically speaking, further highs in equities seem more likely than not. A key to further equity market strength will be positive developments on the economic front. The coming shortened trading week will see a large number of economic reports release that should shed some light on the state of the U.S. economy.

Thursday, June 26, 2014

Corporate Cash Is King

Earlier this week Factset Research (FDS) released their Cash & Investment Quarterly for the S&P 500 Index covering the first quarter. Notable was the near 46% growth on a year over year basis in shareholder distributions (dividends plus buybacks) totaling $193.8 billion. The report also notes share repurchases alone were higher by 50% in the first quarter.

From The Blog of HORAN Capital Advisors

Other notable highlights from the report:
  • "Aggregate Cash Grew 7%: The S&P 500 (ex-Financials) cash and marketable securities balance grew 6.6% year-over-year to a balance of $1.34 trillion at the end of Q1. However, cash declined sequentially by 4.7%, primarily as a result of Verizon Communications (VZ) closing its acquisition of the remaining stake of Verizon Wireless."
  • "Free Cash Flow Grew 9%: Cash flows from operations amounted to $282.0 billion in Q1, which marked an increase of 7.4% year-over-year. Free cash flow to equity increased by 8.7%."
  • "Capital Expenditures Grew 6%: Capital expenditures (“CapEx”) accelerated growth to 6.2% in Q1. In the past four quarters, growth had not exceeded 1.5%. Analysts project that the 2014 growth rate for CapEx will be 6.7%, but also predict it will turn negative in 2015 (-1.2%)"
  • "Net Debt Issuance Positive for Fifteenth Straight Quarter: Cash inflows from net debt issuance were positive for the fifteenth straight quarter. Inflows of $74.1 billion were the second highest quarterly amount over that period."
The growth in capital expenditures is noteworthy as it does not include expenditures that are attributable to acquisitions. The entire report is worth evaluating as it provides insight into the cash generating capability of companies in Q1 in spite of the weakness that is being blamed on the winter weather.

Disclosure: Long VZ