Monday, February 20, 2017

The Significance Of The S&P 500 Yield Falling Below The 10-Year Treasury Yield

For most of 2016 the dividend yield on the S&P 500 Index was greater than the yield on the 10-year U.S. Treasury. Historically, this has served as a positive sign for forward stock price returns. With the strong equity market returns in 2016 and the move higher since the election, the S&P 500 yield is now lower than the 10-year Treasury. In addition to the move higher in stocks, bond prices have declined as well (a higher yield) resulting in bonds now having a higher yield than the S&P 500 Index.

Sunday, February 12, 2017

Recent Outperformance Of Low Volatility A Sign Of Risk Off Ahead?

Since the election in the U.S. it has been a 'risk on' environment for stock investors. Last week though, the Powershares Low Volatility ETF (SPLV) broke out of a sideways trading range to the upside. At the same time, the Powershares High Beta ETF (SPHB) remains trapped in a sideways range. Might the move higher in the low volatility ETF be a signal there is underlying action by some investors to be more defensive in anticipation of a potential pullback on the horizon? The third chart below compares the high beta ETF performance versus the low volatility ETF performance since the election and high beta has far outperformed low volatility.

To better understand what is and is not working in both of these ETFs, following is a summary of the sector attribution for both investments.

The first table above shows some of the attribution for the low volatility ETF (SHLV) compared to the S&P 500 Index. Notable for SHLV:
  • The consumer staples weighting is nine percentage points higher than in the S&P 500 Index. This added 21 basis points to the overall outperformance. 
  • the utility sector is 19 percentage overweight versus the S&P 500 Index and this added 17 basis points to the outperformance
  • SHLV contains no energy stocks and this added a small 3 basis points
In regards to the high beta ETF (SPHB), notable differences versu the S&P 500 Index are:
  • the financial sector is 15 percentage poitns overweight compared to the S&P 500 Index and this added 30 basis points to its outperformance
  • SPHB is 20 basis overweight to the S&P index and this resulted in a negative 44 basis point versu the S&P and noting SHLV contains no energy positions.
  • SPHB is comprised of no consumer staples positions and this cost the index 10 basis points versus the S&P 500 Index and a full 1.68% versus the low volatility index, SHLV.
The equity markets, and specifically the S&P 500 Index, seem to know only one direction and that has been up. Since the election the U.S. the S&P 500 Index is up 8.8% through the close on Friday and the index is up 27.8% on a one year basis. As Charles Kirk of The Kirk Report has been saying about this market,
"At this point, the continued strength is starting to overcome the historical pattern for a post-inaugural pullback in the first month...The Bottom Line: It remains a bull market until proven otherwise [emphasis added]...and prices are still not showing any new signs of vulnerability as the test of upper trendline resistance begins."
I have written recently that individual investor sentiment reported by AAII is trending more cautious and the below chart also points to a similar conclusion.
One week certainly does not constitute a trend. However, the strength of the S&P 500 Index advance over the last eight years and the recent extreme low volatility of the broader market warrants one to expect a pullback in stocks. The S&P 500 Index has not seen a move of greater than +/-1% since December 7, 2016.

It is apparent the defensive sector weighting of SHLV has benefited its return against both the high beta ETF and the S&P 500 Index, i.e., over weight in staples and utilities.  Longer term though, the balance of the year, we continue to believe stocks will reward investors.

Saturday, February 11, 2017

Positive Sentiment And Fundamentals Rests On Positive Political Expectations

I believe there are two broad issues at play that are having a positive influence on equity prices. The first issue is a fundamental one and related to a much improved corporate earnings picture. Looking solely at companies in the S&P 500 Index, Thomson Reuters publishes a weekly report summarizing the quarterly earnings reports of companies. Friday's report notes,
  • Q4 '16 earnings are expected to increase 8.4% on a year over year basis. The financial sector is projected to show the strongest YOY growth at 20.8%
  • Of the 357 companies in the S&P 500 that have reported earnings to date for Q4 2016, 68.3% have reported earnings above analyst expectations. This is above the long-term average of 64% and below the average over the past four quarters of 71%.
  • 48.3% of companies have reported Q4 2016 revenue above analyst expectations. This is below the long-term average of 59% and below the average over the past four quarters of 51%. Revenue growth for Q4 '16 is estimated to equal 4.4% YOY.
The second issue influencing the market is the dramatic positive shift in sentiment by both consumers and businesses. I could probably show a dozen different charts that support the positive shift in sentiment with just two of them below. The first one measures CEO Confidence and it had one of  the largest month over month increases in the measure's history. The second one shows consumer sentiment jumping higher subsequent to the election as well.

Monday, February 06, 2017

Room For More Debt?

As was mentioned in a previous post, S&P 500 companies have taken advantage of cheap debt to fund continued capex and share buybacks since the recession.  This has driven total debt to new all-time highs.  Though there has been much concern about the "abuse" of low interest rates to create a rally fueled by buybacks, it does not strike me as much of an issue.  In fact, it makes sense for companies to take advantage of cheap debt to lower their WACC with the potential side effect that they shift their capital structure.  Interestingly, however, the capital structure has not shifted with this proliferation of cheap debt.

The total debt to book value of equity ratio appears to be at a reasonable level.  If anything, it looks like there may be room for additional debt for S&P 500 companies.  This is even more true when coupled with the very low interest expense burden.  It is not that debt has not grown since the last recession, it clearly has, but the book value of equity has grown much faster.

I am not necessarily campaigning for these companies to take on more debt, but rather observing that corporate debt (at least in the S&P 500) does not seem to be nearly as big a problem as is often reported.

Sunday, February 05, 2017

Dogs Of The Dow 2017: Know The Strategy's Bets

The Dogs of the Dow strategy is one where investors select the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Index (DJIA) after the close of business on the last trading day of the year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year. The popularity of the strategy is its singular focus on dividend yield.

As we noted in a year end post, the Dogs of the Dow strategy in 2016 did outperform both the S&P 500 Index and the Dow Jones Industrial Average Index last year. However, the strategy is somewhat mixed from year to year in terms of outperforming the Dow index though. Over the last ten years, the Dogs of the Dow strategy has outperformed the Dow index in six of those ten years. For investors utilizing the strategy it is important to be aware of where ones bets are in terms of stock and sector exposure.

Essentially one months has passed in 2017 and the Dogs of the Dow strategy is underperforming both the Dow index and the S&P 500 Index. Below is a table noting the year to date performance of the current Dogs.

In evaluating the performance difference, investors will note the largest detractor from performance is related to the energy sector. The 2017 Dow Dogs contain two energy stocks, Exxon Mobil (XOM) and Chevron (CVX). In 2016 the energy sector was the best performing sector in the S&P 500 Index, up 28%. To date in 2017, for the S&P 500 Index, energy is the second worst performing sector, down 2.5%, followed by telecom stocks which are down 3.3%.

The below table details the attribution analysis of the Dow Dogs to the Dow Jones Industrial Average Index itself.  As one can see, the Dogs of the Dow strategy is overweight to the energy and telecom sectors, thus, detracting from the strategy's year to date performance. Also of note is the absence of holdings in the Financial, Materials and Consumer Discretionary sectors. In comparison to the S&P 500 Index, the Dogs, and the Dow index itself for that matter, do not contain positions in utilities or REITs.

For investors then, if the Dogs of the Dow strategy is one being pursued, it is beneficial to know where the strategy's bets are in terms of stocks and sectors. As noted previously, the Dow Dogs contain no materials stock positions and this sector is the second best performing sector in the Dow Index and the S&P 500 Index. Also, if one believes financial stocks can continue to perform well this year, the Dow Dog strategy is absent any financial positions. At the end of the day, investors will benefit knowing what they own and the economic exposure of these holdings.