Tuesday, March 31, 2009

Value Line Introduces New Dividend Focused Model Portfolio

This week Value Line (VL) introduced a new model portfolio that will consist of companies with above market dividend yields. The benchmark for the stocks in the portfolio will be the U.S. Broad Dividend Achievers Index ($DAA.X).

The Value Line portfolio will begin with a market value of $1 million and initially consist of 20 equally weighted companies. VL will rebalance the portfolio from time to time in order to keep the stock weightings between 4-6%. VL notes:
"...many of the dividend payers of final interest will likely tend to be large, more established, companies with market capitalizations of more than $5 billion, and this select set will comprise the bulk of our group. In an effort to boost returns, though, we will also seek out mid-cap stocks with good dividend prospects."
The initial portfolio of companies are detailed in the below table.

(click to enlarge)

Value Line above market dividend yield portfolioSource: Value Line

According to Mergent and its Index company, Indxis:
"The Broad Dividend Achievers™ Index is comprised of companies incorporated in the United States or its territories, trade on the NYSE, NASDAQ or AMEX, and have increased its annual regular dividend payments for the last ten or more consecutive years. In addition, Indxis requires that a stock's average daily cash volume exceed $500,000 per day in the November and December prior to the annual reconstitution date on the last trading date in January. The Index is calculated using a modified market capitalization weighting methodology and has been published by the American Stock Exchange under ticker symbol DAA."
Value Line will provide weekly portfolio commentary in its Selection & Opinion publication.

Saturday, March 28, 2009

Investor Sentiment As Of March 26th

Investor bullish sentiment reported earlier this week by the American Association of Individual Investors indicated a decline in the bullish sentiment level. Bullish sentiment was reported at 39.13% versus last week's level of 45.06%. Most of the bullish investors turned bearish causing the bull/bear spread to turn negative. This week's bull/bear spread equals -3% versus last week's spread of +7%. Although the eight period moving average of bullish sentiment did tick higher this week, the trend for this indicator has been declining since January 2004. It could be the strong move in the market since March 9th is causing investors to take a little money off of the table.

(click to enlarge)

Are Homes A Good Investment?

On an inflation adjusted basis, homes prices have fallen 33% from the peak in 2005. The below chart shows single family home prices are now back in a range that existed from the late 1970s into the mid-1990s. Chart of the Day notes, "...a home buyer who bought the median priced single-family home at the 1979 peak has actually seen that home lose value (1.6% loss). Not an impressive performance considering that nearly three decades have passed."

(click to enlarge)

inflation adjusted single family home price chart 1970-2009

Thursday, March 26, 2009

Buybacks Dry Up But Dividends Trend Higher

Standard & Poor's reported that share buybacks in the 4th quarter of 2008 feel 66% compared to the 4th quarter of 2007. Conversely, on a sequential basis, dividends actually trended higher to $62.19 billion versus $61.44 billion in the 3rd quarter of 2008. The fact aggregate dividends did trend higher in the 4th quarter is proof there are companies that continue to increase their dividend. Dividend growth companies tend to be more committed to continuing dividend payments versus a continued commitment to a stock buyback.

(click to enlarge)

S&P 500 Index buybacks 4th quarter 2008 chartHoward Silverblatt, Senior Index Analyst at Standard & Poor’s noted,
"The need to conserve capital in the current recession, combined with the uncertainty of future cash flow, has made buybacks a high risk component for corporate planners. Due to the current market environment, we expect buybacks to remain weak with the potential for companies to use existing treasury shares (emphasis added) to satisfy options, as well as smaller M&A."
S&P prepared a report mid year 2007 noting the risk of these treasury shares on a company's balance sheet if the shares were not actually retired. If the shares are not retired they can be reissued and dilute existing shareholders, thus defeating the benefit of the original buyback. As Howard Silverblatt noted above, companies may use existing treasury shares to satisfy option execution.


S&P 500 Stock Buybacks Retreat 66% in Fourth Quarter; Off 42% in 2008
Standard & Poor's
By: Howard Silverblatt and Dave Guarino
March 26, 2009

Wednesday, March 25, 2009

S&P 500 Market Cycle And Gold

Given the magnitude of the up moves and down moves in the stock market since 2000, many stock investors are now wondering what their investment approach should be going forward. Certainly evaluating ones risk tolerance at this point in the market cycle is appropriate. Assuming some level of equity exposure will remain a part of ones overall portfolio allocation, what type of market movement might investors expect going forward. Technical strategists are looking to the movement in gold (GLD) prices for insight, but note, I am not a gold bug.

As the below chart of the monthly closing prices for the S&P 500 Index ($INX) notes, the index reached 1,517.68 in August 2000 and subsequently declined 46.2% to 815.28 in September 2002. The market had moved down over 20% before 9/11. The S&P then recovered to 1,549.38 over the next five years ending on October 2007. Since October 2007 the market has proceeded to decline over 50% to the February closing price of 735.09.

(click to enlarge)

S&P 500 chart 1971 to 2009Since reaching 735 in February, the S&P 500 Index ($INX) has recovered some ground and closed at 806.25 today. This closing price is just below the September 2002 close of 815, which may serves as resistance for the market.

(click to enlarge)

S&P 500 chart as of March 24,2009What investors need to keep in mind is we are still in a secular bear market. However, shorter term bull market moves can and do occur during these phases. One question then is how long will the bear market last.

The below table from Crestmont Research details bull and bear market cycles using the Dow Jones Industrial Average Index ($INDU) going back to 1901. Up until 1941, bull and bear market cycles tended to be shorter in nature, i.e., lasting four to five years on average. However, beginning in 1942 the market cycles lengthened quite dramatically--averaging about 19 years now.

Secular Bear Market Table

With these longer cycles, it became more common to have cyclical bull market phases within these secular downtrends. For example, in the 1966-1981 bear market the market achieved 9 positive returning years versus 7 negative returning years. The average return for the positive years was 13% and the average for the negative years was -15%. For the entire 16 year period, the market was down a cumulative 10%. One factor is certain and that is one can't predict when the end of this bear cycle will occur.

As noted earlier though, strategists are turning to gold for potential clues. An investor can think of this as someone making the decision to invest in paper assets (stock) versus hard assets (gold). The below chart shows the monthly closing price of the Dow Jones Industrial Average (green line) and the Dow Index divided by the price of gold (red line).

(click to enlarge)

Dow jones Industrial Average and Dow/Gold ratio
Historically, the Dow Index has bottomed when the Dow/Gold ratio fell to 3 or lower. The ratio was about 7 when the market hit its recent low of 6,547 on March 9, 2009. The Dow Index is used most frequently since data on that index goes back to 1896 and the S&P 500 Index was first created in 1957. The chart of the S&P 500 Index priced in relation to gold is detailed below.

(click to enlarge)

S&P 500 Index and S&P 500 priced in GoldThe chart moves seem dramatic so the below chart uses a logarithmic scale for gold and the S&P 500 Index. A log scale is essentially charting the same percentage moves. For example, the distance from 10 to 100 on the chart is the same as the distance from 100 to 1,000.

(click to enlarge)

S&P 500 Index and S&P 500 priced in Gold log scale
A couple of takeaways from this information for investors.
  • we are likely still in a bear market, but cyclical bull markets are not uncommon during this type of market so money can still be made on the long side.
  • in reviewing the secular bull & bear market chart above, the stock valuations (P/E) at the end of bear markets tended to be around 10 or less. The current 10 year trailing P/E is 14. This market decline has reduced the valuation on a number of high quality stocks so investors may want to consider building positions in those type of equities.
  • many investors have a desire to add bonds/fixed income to their portfolios. From an overall asset allocation perspective, fixed income can act as a shock absorber in down market periods. Interest rates are at record lows though and the fed is pumping money into the economy in hopes of stimulating future growth. This type of stimulus has tended to be inflationary. If growth and inflation take hold, the Fed will be quick to raise rates. In a rising rate environment, bond prices will fall. In that regard, below is a S&P/gold chart with the Fed Funds rate graphed as well. Given the potential for inflation, investors should consider looking at some type of inflation protected investments in their portfolio.
(click to enlarge)

S&P 500 Index and S&P 500 priced in Gold with Fed Funds rate 2009

Sunday, March 22, 2009

Is Benjamin Graham Still Relevant?

A few years ago, Jason Zweig worked with the publisher of The Intelligent Investor in order to update the classic investment book. Zweig made it clear to the publisher that he would not rewrite any of what Graham had written. Zweig outlines some of the thoughts that went into the 2003 update of the Intelligent Investor in a paper titled, Equity Analysis Issues, Lessons, and Techniques.

Graham gets criticized by some analyst because some of Graham's formulas seem outdated. For example, in the late 1990's Jim Cramer commented,
"You have to throw out all of the matrices and formulas and texts that existed before the Web. . If we used any of what Graham or Dodd teach us, we wouldn’t have a dime under management."
It should be noted though, Graham constantly retested and reworked his formulas over time and in subsequent editions of the book. Zweig states in the above noted paper:
"Of course they are! They are the ones he used to replace the formulas in the 1965 edition, which replaced the formulas in the 1954 edition, which, in turn, replaced the ones from the 1949 edition, which were used to augment the original formulas that he presented in Security Analysis in 1934." Graham constantly retested his assumptions and tinkered with his formulas, so anyone who tries to follow them in any sort of slavish manner is not doing what Graham himself would do if he were alive today.
Zweig characterizes Graham's relevance into five factors with detail found in the below link to the article.
  • intellectual brilliance
  • financial brilliance
  • prophetic brilliance
  • psychological brilliance
  • explanatory brilliance.
So why did Graham title his book the Intelligent Investor? In the first edition (1949) of the book, Graham defines what he means by intelligent.
will be used throughout the book in its common and dictionary sense as meaning "endowed with the capacity for knowledge and understanding." It will not be taken to mean "smart" or "shrewd," or gifted with unusual foresight or insight. Actually the intelligence here presupposed is a trait more of the character than the brain.
Zweig expands on the last sentence to mean,
The components that are needed in the character of an intelligent investor are patience, independent thinking, discipline, eagerness to learn, self-control, and self-knowledge.
And many followers of Graham have memorized the one passage on independent thinking that seems to sum up his philosophies:
"you are neither right nor wrong because the crowd disagrees with you. You are right because your data and your reasoning are right."
Warren Buffett recites this phrase at nearly every annual meeting of Berkshire Hathaway (BRK/A). According to Buffett,
Investment managers must be independent. They must tell their clients that worrying about the information ratio and tracking error is not part of their process. If they do not establish the independence of their thinking, managers (and independent investors) will end up turning a basic advantage into a basic disadvantage. They will become trapped in the measurement and benchmarking game, which pretends that managers can outperform the market while maintaining portfolios and strategies that look exactly like the market.
Lastly, what Graham had to say about management and owners as recently as 1972, could apply today's management issues. In the 2003 edition that Zweig participated in, he tried to add back the "lost Ben Graham." Some of the lost Ben Graham in the 1972 addition did appear in the 1949 edition. At the suggestion of Warren Buffet, Zweig added some of the management material.
For example, in the 1972 edition, Chapter 19 was eight pages of perfunctory remarks about dividend policy. When I went back to the 1949 edition (on the suggestion of a certain resident of Omaha), I discovered that one-third of the original book was given over to a discussion of what Graham called "the investor as stockholder."
In these passages, Graham explained the responsibilities that come with owning companies.
"Nothing in finance," he wrote in 1949, is more fatuous and harmful, in our opinion, than the firmly established attitude of common stock investors and their Wall Street advisers regarding questions of corporate management. That attitude is summed up in the phrase: "If you don’t like the management, sell the stock." In the 1934 edition of Security Analysis, Graham reinforced this idea with the following classic formulation, "Certainly there is just as much reason to exercise care and judgment in being as in becoming a stockholder."
And what does Warren Buffet say about Benjamin Grahman's relevence in today's market?
"I read the first edition of this book early in 1950, when I was 19. I thought then that it was by far the best book about investing ever written. I still think it is."
The entire article is detailed below and was obtained via the University of South Dakota.
Lessons Ideas Benjamin Graham

Saturday, March 21, 2009

AIG Lynch Mob!

As much as the bonuses to some of the AIG employees that contributed to the financial situation we face today are inappropriate, the solution from Congress leads the country in a dangerous direction. David R. Kotok co-founded Cumberland Advisors and he wrote an interesting commentary today that is well worth the read.

(The below article originally appeared on The Big Picture website.)

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


A Lynch Mob!
March 21, 2009

“Let’s go hang ‘em.”

American history is replete with examples of lynch mobs taking control of a situation and inflicting injustice. In the end most lynch mobs have dealt harmful blows to society. Congressional action to punish AIG employees over the bonus issue is already seeding that outcome.

Members of the US House of Representatives who voted for this bill said they were reacting to the anger of their constituents. In failing to show leadership they have just undermined the entire structure designed to repair the financial system.

Specifically the House did the following:

1. They licensed the abrogation of contracts. Their message is simply that it makes no difference what rules we put into effect now; we can and will change them so you cannot depend on them. Global businesses take heed: Your previous judgment about the sanctity of US law has been rendered faulty by our political leadership.

2. They passed retroactive taxation. Their message is that, whatever you plan with regard to the federal tax code, do not assume consistency and do not build any reliability about your government into your decision making. We, in Congress, can reverse our laws and confiscate your results.

3. They made the tax punitive. A 90% tax on something is like taking all of it. The chairman (Rangel) of the House taxation committee actually admitted that by taxing the 90% he was leaving the remainder for the states. In other words, states are now encouraged to engage in the same form of behavior.

Sure citizens are outraged over the $165 million in bonus payments to AIG staff. But they should direct their outrage at the Congress and not threaten the employees or their families with personal injury. The Congress authorized these payments; Dodd, Geithner, and Obama Administration personnel admitted that. Remember, the law passed without giving anyone the chance to testify in public hearings and without allowing comment on the draft legislation. When the law originally went through the Congress, the House leadership suppressed amendments. This Barney Frank and Nancy Pelosi-led House is especially guilty of ignoring the rule of law. They are now guilty of encouraging the rule of lynch mob.

The result of this House action is already damaging. The federal regulator of Fannie Mae and Freddie Mac has shown the courage to ask that this law not be advanced in the Senate. We expect to hear more from those federal personalities who have the strength to speak up and oppose this House-approved proposal.

But depending on the Senate to soften the law or depending on the US Supreme Court to overturn it is a dangerous strategy. Some Congressmen admitted privately that they voted in favor because of constituent pressure, even though they were really opposed to the concept. They voted “yes” because they were relying on the Senate or the courts to say “no.”

Some damage is already done. Firms that were gearing up to participate in the federal program to be announced this coming week are considering withdrawal. They fear that any action which puts them into the federal assistance plan will subject them to the chance of retroactive punishment and taxation. The House has undermined the so-called public-private partnership designed to help restore financing of consumer items like automobiles and credit cards. We expect that the participation in the program to be announced this coming week will be tepid at best.

At Cumberland, we are advising institutional clients to take great care when engaging in any form of activity with the federal government. Simply put: a lynch mob can turn on you in a second and cannot be trusted. The risk is now very high.

Other firms that are already acting with TARP monies, or other federal monies for that matter, are seeking ways to deleverage and exit. In the entrepreneurial and risk-taking business and financial community the universal response to this act by Congress is outrage and distrust and disgust.

So far President Obama is silent on this lynch-mob approach. He has yet to declare himself against it.

Obama needs to be reminded of a parallel in history. A century ago a man named Leo Frank was lynched in Georgia for a murder he did not commit. Local politicians supported the lynch mob; those courageous politicians that opposed it were voted down. Frank was an innocent victim. His subsequent posthumous pardon did not undo the harm.

A century later a man named Barney Frank brags about the earmarks he obtained for his Congressional district (see his website). This modern Frank foments the modern-day version of a lynch mob. The House of Representatives and the Financial Services Committee under the leadership of Barney Frank have made the first day of spring, 2009 a sad day for America. They suppressed the rule of law; they chose the rule of the lynch mob; they are now going to have to live with that result.

When the citizens of America realize what the House has done, they may redirect the lynch mob against the Congress. That is coming next. As Yogi Berra said: “This ain’t over till it’s over.”


We fly to Europe in a few hours and will chair the Global Interdependence Center delegation at the Paris conference next week (see www.interdependence.org ). Meetings will include central bankers, global investors, and businessmen. Our private roundtable will now also address this House action and what it means for US policy and American markets. Current scheduling from Paris includes CNBC on Monday at 10 AM New York time and again on CNBC on Tuesday morning at 5 AM New York time.

David R. Kotok, Chairman and Chief Investment Officer, email: david.kotok@cumber.com

H/T: Barry L. Ritholtz of The Big Picture

Tobin's "q" Ratio Continues To Decline

The Tobin's "q" ratio measures the market value of a company to the replacement cost of its net assets. This ratio can be applied on the market value for the stock market relative to the replacement cost of these companies' assets.

For the 4th quarter of 2008, Argus Research notes the "q" ratio has continued to decline to .62 which is the lowest level sine the 4th quarter of 1991.

(click to enlarge)

According to Argus:
"the ratio of total stock market value to corporate net worth is a reliable indicator of market valuation. When the stock market trades at a discount to the replacement cost of its assets, the market is inexpensive, and assets are cheaper to buy than build. This discount is reflected in "q" ratios below 1.0. Conversely, when "q" exceeds 1.0, the market trades at a premium to asset replacement costs and is considered [expensive]. The long-term average (since 1952) for Tobin’s "q" is 0.76."
Additional information on Tobin's "q" ratio can be found in one of my earlier posts that is titled Tobin's "q".


Tobin’s ‘q’ at 0.62 in 4Q ($)
Market Watch: Daily Spotlight
March 20, 2009

Thursday, March 19, 2009

Bullish Investor Sentiment Spikes Higher

It is amazing what one positive week in the equity markets can do for investor sentiment. Over the seven trading days ending on March 18th, the S&P 500 Index ($INX) is higher by more than 17%. True to form the American Association of Individual Investors reported investor bullish sentiment increased by 17 percentage points to 45.06%. The bull/bear spread came in at a positive 7% versus last weeks -27% and the week prior to last the spread was -51%.

investor sentiment bull bear spread table March 19, 2009
(click to enlarge)

bullish investor sentiment chart March 19, 2009Source: American Association of Individual Investors

The AAII's sentiment indicator tends to be a volatile one on a week to week basis. However, the magnitude of the switch from bearishness to bullishness s worth noting. Could this lead to the record level of sideline cash finding its way into the equity markets?

Wednesday, March 18, 2009

Oracle Corp: New Dividend and Currency Impact

After today's market close, Oracle Corporation (ORCL) announced fiscal 2009 Q3 GAAP earnings per share were $0.26, up 3% compared to last year. The earnings results were 3 cents ahead of analyst expectations. The strong dollar had a significant impact on results for the quarter. If currency exchange rates were the same as they were in Q3 of last year, Oracle's Q3 GAAP earnings per share would have been up 18% to $0.31 rather than up 3% to $0.26. After the Fed's announcement that they would be purchasing mortgage back securities and treasuries, the Dollar turned decidedly weaker though.

(click to enlarge)

U.S. Dollar chart March 18, 2009In addition to Oracle's earnings news, the company announced it would begin paying a dividend of 5 cents per share with the ex-date around April 6, 2009. This is the company's first dividend since trading as a public beginning 23 years ago.

(click to enlarge)

Oracle stock chart March 18, 2009

Monday, March 16, 2009

Better Investing's Most Active

BetterInvesting informally solicits their members on which companies are attracting the most interest according to members' recent buy and sell decisions. The below results are taken from a small, informal sampling -- 152 transactions -- for the trailing 4-week period ended Monday, March 16, 2009.

(click to enlarge)

BetterInvesting also maintains an index, BetterInvesting 100 Index (BIXX), that represents the top 100 companies held by BetterInvesting's 13,000 investment clubs. This Index has outperformed the Dow Jones Industrial Average by more than 14 percent since March 2003.

(click to enlarge)

Chart BetterInvesting Top 100 and S&P 500 Index march 16, 2009

Sunday, March 15, 2009

Now Obama Favors Taxing Health Care Benefits

During the presidential campaign, President Obama aggressively opposed John McCain's idea of taxing an employee's health care benefit. For what it is worth McCain's proposal would have offered some form of credit. During the campaign Obama indicated this type of tax would amount to a large tax increase on the middle class. The New York Times is reporting in an article this morning, Administration Is Open To Taxing Health Benefits, that the Obama administration may now favor taxing employees' health care benefits.

Washington and the Obama administration need to read the history books that cover the Great Depression. One factor that is cited as pushing the country into the Great Depression, was the government's policy of raising taxes and tariffs. The Obama budget that has been proposed and tweaked continues to take more money out of consumer pockets by raising additional taxes. Consumers lose the ability to spend and lose confidence as more proposals are brought forth that raise taxes on consumers.

If this proposal gains traction, I suspect the stock market will not look favorably on this tax increase. This proposal could reverse last week's gains.

Saturday, March 14, 2009

Business Confidence Remains Weak

Much attention is placed on consumer confidence since consumers have accounted for 70% of GDP over the course of the recent past. As important though is the confidence CEOs see in their business and the economy.

The accounting firm, PriceWaterhouseCoopers, has conducted a survey of global CEOs over the past 12 years. In this year's survey completed in December of last year some important results are reported. PwC notes:
CEOs around the world are retrenching, indeed many claim to be entering ‘survival mode.’ Our 12th Annual Global CEO survey shows how the financial crisis shattered short-term confidence. The percentage of CEOs who were ‘very confident’ about their one-year revenue growth prospects dropped to 21%, the lowest level in six years. Uncertainty about the future is still running high and confidence no doubt continued to deteriorate after we completed the survey in early December.
Following are a few findings from the survey.
  • Q: How would you assess your level of confidence in prospects for the revenue growth of your company over the next 12 months?
  • Q: How would you assess your level of confidence in prospects for the revenue growth of your company over the next 3 years?
business confidence long term
And a look at the impact on confidence over a shorter time frame.

(click to enlarge)

business confidence short termThis lack of confidence about future business prospects is leading firms to delay planned investments.
Nearly 70 percent of CEOs say that their companies will be affected by the credit crisis. Of those, nearly 80 percent say that they face higher financing costs, and nearly 70 percent say that they will delay planned investments as a result. Companies in the banking, utilities, construction, entertainment and automotive sectors are most likely to be affected.
The lower level of confidence has led to staff reductions. On the positive side, it appears firms are reducing the prospects for additional staff reductions. Keep in mind this survey was completed in December and the early part of 2009 may have changed company thoughts on the staffing issue.
  • Q: What do you expect to happen to headcount in your organisation globally over the next 12 months?
CEOs expectations for future staffing reductionsIn addition to Washington paying attention to consumer confidence, policy makers will need to focus on the confidence business executives have in the prospects for their businesses.
  • Q: How important are the following aspects of a country’s tax regime at influencing your investment decisions?
(click to enlarge)

importance of clarity on taxes
The uncertainty around taxes and regulation do contribute to the lower confidence level experienced by the CEOs of global businesses.


12th Annual Global CEO Survey: Redefining Success (pdf)

Dividend Cuts No Worse Than In Prior Economic Slow Periods

Investors continue to be rewarded with better risk adjusted returns by maintaining a focus on investing in dividend growth stocks. A recent report from Oppenheimer contained a Ned Davis Research chart noting the dividend growers and initiators continue to achieve higher risk adjusted returns for the period 1972 - 2008.

(click to enlarge)

risked adjusted return dividend increase stocks chartAdditionally, dividend cuts seem to be coming at a fast and furious pace. However, cuts in this cycle are really no worse than cuts in prior economic slowdowns. I saw a chart recently (can't locate the source now) that noted dividend cuts, excluding the financial sector, are no worse than prior periods as well.

(click to enlarge)

quarterly dividend change S&P 500 Index since 1944Source: Bespoke Investment Group

For investors then, continuing to focus on stocks/companies that increase the company's dividend on an annual basis can be a rewarding investment approach.


Seeking Dividend Growth Over Time (pdf)
January 26, 2009

Global Equity Market Correlations Continue To Increase

Standard & Poor's reports global equity market correlations continue to increase. The downside has been the fact diversification has not minimized investors' downside losses during the global market contraction.

(click to enlarge)

Global equity market correlations February 2009A potential positive is global markets could rise in near unison; thus enhancing future returns when markets recover--whenever that might occur.


Crushing Correlation ($)
Standard & Poor's The Outlook
By: Alec Young, International Equity Strategist
March 18, 2009

Thursday, March 12, 2009

Not Convinced This Is "THE" Bottom-Yet

Reviewing the weekly chart for the S&P 500 Index, it appears recent market action resembles the action that occurred in the October through December period late last year. Friday's trading activity/volume will be interesting as it appears the volume for the week could be below earlier up weeks.

(click to enlarge)

s&p 500 weekly chart March 12, 2009Even reviewing the daily chart, up volume is coming in light. Undoubtedly, there are some technical positives, i.e., favorable MACD and improving relative strength index.

(click to enlarge)

s&p 500 daily chart March 12, 2009
Investors need to keep in mind the market will anticipate a better fundamental economic picture about six months before the economy begins to improve. Given the depth of this contraction, one data figure I am watching is the inventory to sales ratio. Once inventory gets down to a low enough level, manufacturers will need to ramp up production and hopefully hire more employees.

Today's inventory to sales data was somewhat positive on the whole. The inventory to sales ratio came in at 1.43 and was unchanged from December's reading of 1.43. Compared to the January of 2008 inventory/sales ratio of 1.25, it is evident inventories remain elevated though.

(click to enlarge)

inventory to sales chart January2009The U.S. Census Bureau announced today,
  • the combined value of distributive trade sales and manufacturers’ shipments for January, adjusted for seasonal and trading-day differences but not for price changes, was estimated at $1,004.0 billion, down 1.0 percent from December 2008 and down 14.0 percent from January 2008.
  • Manufacturers’ and trade inventories, adjusted for seasonal variations but not for price changes, were estimated at an end-of-month level of $1,440.1 billion, down 1.1 percent from December 2008 and down 1.5 percent from January 2008.
Sales continue to contract at a more rapid rate than inventories. The data for the discretionary consumer items has not improved as well.

(click to enlarge)

inventory and sales data January 2009Although inventories have been reduced on a sequential and year over year basis, sales continue to decline at a more rapid rate.

I believe this consumer oriented data is worth watching closely in order to provide a sign that improvement in the economy is taking hold. Given positive market performance, the consumer's sentiment can turn more positive fairly quickly. As noted in an earlier post, The President Should Pay Attention To The Market--It Does Matter, consumer sentiment is somewhat impacted by the direction of the stock market.

Bears Become More Bullish

In the sentiment survey released this week by the American Association of Individual Investors, bullish sentiment increased to 27.64% versus last week's reading of 18.92%. The increase in investor bullishness came from a reduction in bearish sentiment. The bearish sentiment declined to 54.47% versus last week's bearishness reading of 70.27%. The bull/bear spread narrowed to -27% versus -51%. The bullish sentiment remains below the long term average of 38.9% and the bearish sentiment remains above its average of 29.8%.

(click to enlarge)

Wednesday, March 11, 2009

Cash Rich Companies

Argus Research recently provided a list of sixteen cash rich companies with market caps greater the $1 billion.

(click to enlarge)

cash rich companies as of February 27, 2009Additional screeening criteria included:
  • Cash & cash equivalents per share that are at least 25% of the share price.
  • Trailing 12-month cash flow per share of at least $2.00.
  • An estimated long-term growth rate of at least 5%.
  • Total debt that is less 20% or less of capital.
The Argus screen also required trailing 12-month cash flow of at least $2.00 per share and a long-term earnings growth rate of at least 5%. Additionally, they screened out companies that have high or medium-high borrowings. Lastly, the debt of the company was required to be less than 20% of capital.

Just because a company carries a large amount of cash on their balance sheet, it does not mean the company's stock is necessarily a good investment. Additional research needs to be done to ascertain how the company came to acquire high levels of cash. For example, if the cash was simply raised through the sale of a portion of the company's business, future earnings growth may not support current stock price levels.


Argus Update ($)
Argus Research
April 2009

(Disclosure: I have a long interest in Flour and Cisco)

Tuesday, March 10, 2009

Market Not Out Of The Woods Yet, But Some Positives

One day does not make a trend and negative factors continue to impact the market in spite of the strong advance today. Today's up volume is lower than past large up days in the S&P 500 Index. This could be a sign that the buying strength was due in large part to short covering.

(click to enlarge)

S&P 500 Index chart March 10, 2009We are now seeing some positives noted in prior posts that could provide a better tone for companies and investors:
Beyond my concerns for fundamental aspects of the economy (the inventory to sales ratio continues to move higher), I still believe we may yet see a capitulation trading day.

Monday, March 09, 2009

The President Should Pay Attention To The Market--It Does Matter

No one data set provides the silver bullet in predicting the direction of the stock market. On the other hand, the stock market's direction does impact consumer confidence. The market does matter and the decline so far this year is over 25%. Now I know other factors impact confidence levels, but the wealth effect tends to influence the psychological feelings of consumers.

As the below chart details, consumer confidence tends to lag the stock market by about 2-3 months.

(click to enlarge)

consumer confidence and S&P 500 Index chart March 2009

The importance of this one data set is the President should look at actions that impact confidence in a positive way. A positive tone to the market is one factor that can have a positive impact on confidence.

So what has occurred since January that could be impacting the market in a negative way? I can list a large number of factors, but a few are:
  • unresolved financial industry crisis
  • uncertainty about higher taxes. Increasing the bracket rate is one thing, but the uncertainty about the monetary impact on tax payers with the phase out of mortgage deduction, phase out of deductibility of charitable contributions, etc.
  • significant increases in government spending on health care
  • cap and trade tax
  • foreign profits tax
Certainly, other factors tend to influence the direction of the stock market as well, but the wealth effect tends to have a significant influence on confidence. The economic challenges that could result from the recently proposed budget are having a large negative impact on this market.

As Jim Cramer noted in his article on his site MainStreet, Cramer Takes on the White House, Frank Rich and Jon Stewart:
When I somewhat obviously and empirically judged that the populist Obama administration is exacerbating the crisis with its budget and policies, as evidenced by the incredible decline in the averages since his inauguration, I was met immediately with condescension and ridicule rather than constructive debate or even just benign dismissal. I said to myself, "What the heck? Are they really that blind to the Great Wealth Destruction they are causing with their decisions to demonize the bankers, raise taxes for the wealthy, advocate draconian cap-and-trade policies and upend the health care system? Do they really believe that only the rich own stocks? What do they think we have our retirement accounts in, CDs? Where did they think that the money saved for college went, our mattresses? Do they think the great middle class banks at the First National Bank of Sealy and only the wealthiest traffic in the Standard & Poor's 500?"
The current administration should take a look at events that have unfolded this year, many policy driven, and reevaluate the timing of these programs before it is too late economically.

Saturday, March 07, 2009

January and February Worst Two Month Period For Performance In History

The S&P 500 index dropped 8.57% in January and declined 10.99% in February. For this two month period the Index fell 18.62% beating the old record decline of 17.85% in 1933. We are 5 trading days into March and the S&P 500 Index is already down 6.97%. The market has a tendency to seek its direction based on a forward looking perspective. If that is the case, the current market contraction is not looking favorably on the next 6-12 months.

In early December I wrote a post comparing the economic environment then to the Great Depression. In that post I noted:
During the early 30's depression, the government responded by decreasing the money supply and raising taxes and tariffs. It would be helpful if the incoming administration strongly stated it would not raise taxes and tariffs as were proposed during the presidential election campaign.
Well contrary to my hopes back then, the current administration in Washington is proposing significant tax increases along with trade protection measures. Additionally, the administration is proposing massive increases in the government's role in the market.

The most recent is the government's desire to offer health care to all. What this will likely do is enable companies to drop health care as a benefit with the assumption employees can apply for a government health plan. Just as social security is unfunded, if government health care is to be fully funded, significant tax increases will be forthcoming. The current policies out of Washington are not pro economic growth.

No wonder the market continues to contract.

Time Required To Recover Lost Value

Andreas Steiner maintains a performance analysis website containing a number of applications used in analyzing investment performance and investment risk management. Recently, Andreas prepared a presentation noting the magnitude of market declines and the resulting length of time necessary to recover the lost value. Below is the page from the presentation detailing the recovery time periods.

If we are in a period similar to the early 1970's, the market snapback may not be a quick one.

The entire presentation can be reviewed at S&P 500 Drawdown/Recovery period.

Thursday, March 05, 2009

Bearish Sentiment Hits Highest Level Since 1990

This week's American Association of Individual Investors sentiment survey reported the level of individual investor bearishness hit 70.27%. This is the highest bearishness level report by AAII since it began tracking investor sentiment in 1987 when the bearish sentiment reached 67% in 1990. Bullish sentiment feel to 18.92% resulting in a bull/bear spread of -51%.
  • The widest bull/bear spread occurred in 1990 when it reached -54%.
  • This week's bullishness level was reported at 18.92%.
  • The prior low on bullishness was reported in 1990 at 12%.
(click to enlarge)

If we could get any sort of positive news flow, the market would likely make a significant move to the upside.

Wednesday, March 04, 2009

The Fate Of Eastern And Central European Economies Will Have An Impact Globally

For U.S. investors it is easy to have an intense focus on the U.S. economy and the U.S. stock markets; however, the U.S. economy does not function in a vacuum. U.S. investors tend to have a large portion of their investments allocated to their home country stocks, but globalization has tied the fate of all the world economies together. The events unfolding in Eastern and Central Europe need to be watched as negative outcomes will impact all economies and markets around the world.

A week and a half ago, Latvia's government collapsed. As the International Herald Tribune noted,
Latvia's center-right coalition government collapsed Friday, a victim of the country's growing economic and political turmoil and the second European government, after Iceland, to disintegrate because of the international financial crisis.

The government in Riga, faced with forecasts of a severe drop in the economy this year, was the first in Eastern Europe to succumb to turmoil caused by the crisis. Its collapse rounded out a week that saw worries about feeble investment, banks and output in Central and Eastern Europe coursing through international markets.
The problems now inflicting these countries are not much different than those impacting the more developed markets-too much debt. What is complicating matters more in these emerging markets is the way in which debt was loaned to these countries and individuals within the various countries.

Money was loaned to these countries and individuals in dollars and euros. In the early stages, borrowers benefited by the weak Dollar and weak Euro. Recently though, when borrowers convert their home currency to the Dollar or Euro it takes almost twice as much of the home currency to purchase, say a Euro because of the strength in the Euro or Dollar. For example, recently it has taken about 11 Ukrainian hryvnia to buy one euro, compared to about 7 just 12 months ago.

A recent report from the Wharton School at the University of Pennsylvania believes a part of the solution is:
To prevent the crisis from turning into a catastrophe, Western nations should provide at least enough help to prevent Central and Eastern European governments from defaulting on their sovereign debt, which would be like the U.S. government defaulting on Treasury bonds, according to Mark Zandi, chief economist and cofounder of Moody's Economy.com.

Ultimately, adds N. Bulent Gultekin, a Wharton finance professor, the West must recognize the facts of life. "If you allow these countries to go under, you are just going to start a chain reaction. If you're a creditor, you don't want your borrower to die."
There is no easy solution to this global credit crisis.


Worry in the West as Eastern and Central European Economies Head South
March 4, 2009

Latvia's Government Collapses
International Herald Tribune
By: David L. Stern
February 20, 2009

Tuesday, March 03, 2009

Paying Attention To Dividends More Important Than Ever

Standard & Poor's has released dividend data for the S&P 500 Index through the month of February. Any dividend investor knows cuts have been coming at a fast and furious pace.

Do in part to the dividend cuts by high profile companies like General Electric (GE), Dow Chemical (DOW) and Macy's (M), just to name a few, companies seem more willing to cut the company dividend at this time in order to preserve cash.
  • Negative dividend actions total 23 in February versus just 2 in February of 2008.
  • Year to date there have been 34 negative dividend actions versus 9 in the first two months of February last year.
  • Not all the cuts are from the financial sector. In January 80% of the cuts were financials; however, in February less than 50% of the cuts were financial firms.
(click to enlarge)

dividend actions for February 2009
An an average return basis, the dividend paying stocks in the S&P 500 Index lost a great deal of ground to the non-payers. The payer's average return in February totaled -20.42% versus -12.52 for the non-payers.

payers vs. non payers performance as of February 2009A detailed listing of the dividend actions in outlined in the dividend action spreadsheet below.

Data Source: Standard & Poor's

Monday, March 02, 2009

Market Decline Not Caused Just By AIG But The Proposed Obama Budget Too

Most media reports today attributed the market sell off to the additional funds injected into AIG by the government.

  • At CNBC: U.S. stocks were shaken by insurer American International Group posting the largest quarterly loss in history.
  • AP/Yahoo Finance: Investors were worried anew about the stability of the financial system after insurer American International Group posted a staggering $62 billion loss for the fourth quarter, the biggest in U.S. corporate history -- and accepted an expanded bailout from the government.
The market has know AIG is a basket case for months; hence, the reason it trades at around 50 cents. The primary reason for the market's decline today is the market voting against Obama's anti-capitalistic budget proposal.

A reader sent me an email with an economic report from BofA/Merrill Lynch written by economist David Rosenberg. The opening paragraph of the report states:
We think of all the major events that happened last week, including all the economic data, the details of the Geithner stress tests, and the Bernanke congressional testimony, the most important in our view was the budget plan unveiled by President Obama on Thursday night. Charles Krauthammer, in his weekend column, said it is “the boldest social democratic manifesto ever issued by a US President”. Clive Crook (page 9 of today’s FT) was even more blunt – “Take this budget at face value, and when Mr. Obama talks about “a new era of responsibility” he does not mean: “We are all in this together”. He means: “The rich are responsible for this mess and it is payback time”. Leftist Democrats are thrilled and rightly so”. What really caught my eye, though, was the appraisal that the New York Times gave the budget plan on the front page of Friday’s edition, specifically the article titled “A Bold Plan Sweeps Away Reagan Ideals” right on the front page.

Sunday, March 01, 2009

Congress Proposing Transaction Tax On Stock Trades

Now how does instituting a tax on stock trading help and who does it really hurt? Congress and Obama have embarked down a very dangerous path.

Unintended Consequences of Levying a .25% Stock Transaction Tax
by Ron Rowland

Congress is considering legislation to impose a securities transaction tax of 0.25% on every stock trade, which of course is equivalent to 0.5% for each round trip. It’s known as H.R. 1068: Let Wall Street Pay for Wall Street’s Bailout Act of 2009.

As currently written, the bill amends the Internal Revenue Code of 1986 to impose a tax on certain securities transactions. The authors presume it will produce enough additional revenue over time to recover the cost of the $700 billion Troubled Asset Relief Program. Representative Peter DeFazio, D-Oregon, authored the bill.

This bill takes the “law of unintended consequences” to new extremes. You and I did not create the problems of Wall Street. You and I did not receive any Bailout Dollars. As taxpayers, you and I are already paying for the TARP. To start charging us 0.5% for each round trip trade is only adding insult to injury.

If you have portfolio turnover of 100% per year, then this tax represents a 0.5% per year burden. If you are a more active trader, perhaps with an average holding time of 25 days, then it robs you of 5% per year. If you do multiple trades a day, then forget it - you are out of business.

If active traders are removed from the market, what happens to volume? It will dry up, of course. Then you and I will be paying more for each transaction in the form of an increased bid/ask spread. The bill claims to recoup the cost of TARP, but I bet they did not factor in the severe volume reduction that the bill would create.

This proposal has a host of other problems, many of which are highlighted in a great article by James Ramage for Traders Magazine entitled Industry Fears Proposal in Congress Would Destroy High-Frequency Trading and Liquidity.

This bill will hurt too many people, and they won’t be the people it is intended to hurt. A ground-swell of opposition is already forming, but with the public’s current anti-Wall Street mood H.R. 1068 could still slip through. If you see the folly of this idea, let your Representative know how you feel.

Highlights From Buffett's 2008 Shareholder Letter

Yesterday, I provided a link to Bershire Hathawy's (BRK.A) shareholder letter that is written by famed investor Warren Buffett. The 23-page letter always contains insightful investing thoughts from Mr. Buffett about the past as well as thoughts about future events that might impact the markets. One example is his comment about making investment decisions that psychologically seem to be the most comfortable:
Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns.
Following are other highlights from the letter:

Inflation & Municipalities
...the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.
Municipal Bond Insurance
Local governments are going to face far tougher fiscal problems in the future than they have to date. The pension liabilities I talked about in last year’s report will be a huge contributor to these woes. Many cities and states were surely horrified when they inspected the status of their funding at yearend 2008. The gap between assets and a realistic actuarial valuation of present liabilities is simply staggering.

When faced with large revenue shortfalls, communities that have all of their bonds insured will be more prone to develop “solutions” less favorable to bondholders than those communities that have uninsured bonds held by local banks and residents. Losses in the tax-exempt arena, when they come, are also likely to be highly correlated among issuers. If a few communities stiff their creditors and get away with it, the chance that others will follow in their footsteps will grow. What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer?
Declining Stock Prices
...we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.
Using The Past To Project The Future
The type of fallacy involved in projecting loss experience from a universe of non-insured bonds onto a deceptively-similar universe in which many bonds are insured pops up in other areas of finance. “Back-tested” models of many kinds are susceptible to this sort of error. Nevertheless, they are frequently touted in financial markets as guides to future action. (If merely looking up past financial data would tell you what the future holds, the Forbes 400 would consist of librarians.)
Treasury Bond Bubble
A few years ago, it would have seemed unthinkable that yields like today’s could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.
Transparency and Regulation
Improved “transparency” – a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks – won’t cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives. Auditors can’t audit these contracts, and regulators can’t regulate them. When I read the pages of “disclosure” in 10-Ks of companies that are entangled with these instruments, all I end up knowing is that I don’t know what is going on in their portfolios (and then I reach for some aspirin).

For a case study on regulatory effectiveness, let’s look harder at the Freddie and Fannie example. These giant institutions were created by Congress, which retained control over them, dictating what they could and could not do. To aid its oversight, Congress created OFHEO in 1992, admonishing it to make sure the two behemoths were behaving themselves. With that move, Fannie and Freddie became the most intensely-regulated companies of which I am aware, as measured by manpower assigned to the task...

In truth, both enterprises had engaged in massive accounting shenanigans for some time. Finally, in 2006, OFHEO issued a 340-page scathing chronicle of the sins of Fannie that, more or less, blamed the fiasco on every party but – you guessed it – Congress and OFHEO.
Commentary about the current housing crisis often ignores the crucial fact that most foreclosures do not occur because a house is worth less than its mortgage (so-called “upside-down” loans). Rather, foreclosures take place because borrowers can’t pay the monthly payment that they agreed to pay. Homeowners who have made a meaningful down-payment – derived from savings and not from other borrowing – seldom walk away from a primary residence simply because its value today is less than the mortgage. Instead, they walk when they can’t make the monthly payments...

The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income. That income should be carefully verified.

Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition.
Receivables and payables by the billions become concentrated in the hands of a few large dealers who are apt to be highly-leveraged in other ways as well. Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with.

Sleeping around, to continue our metaphor, can actually be useful for large derivatives dealers because it assures them government aid if trouble hits. In other words, only companies having problems that can infect the entire neighborhood – I won’t mention names – are certain to become a concern of the state (an outcome, I’m sad to say, that is proper). From this irritating reality comes The First Law of Corporate Survival for ambitious CEOs who pile on leverage and run large and unfathomable derivatives books: Modest incompetence simply won’t do; it’s mindboggling screw-ups that are required.
Government Intervention In Credit Markets
Funders that have access to any sort of government guarantee – banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella – have money costs that are minimal. Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be.

This unprecedented “spread” in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with a favored status. Government is determining the “haves” and “have-nots.” That is why companies are rushing to convert to bank holding companies, not a course feasible for Berkshire.
The above are only some of the highlights. Reading the full 2008 Bershire Hathaway shareholder letter will offer some interesting insights on Mr. Buffett's additional investing views.