Bearish Sentiment Near Early 2003 Level

In the American Association of Individual Investors sentiment survey released today, bullish sentiment moved slightly higher. On the other hand, investor bearishness increased to a level last seen in early 2003. The bearish sentiment this week was reported at 56.12%. This is the highest level since February 20, 2003 when the level of bearishness equaled 57.9%. This sentiment indicator tends to be a contrary one and the market performance since that time seems to support this.

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McCormick & Co. Adds Spice To Dividend

McCormick & Co. (MKC) announced a 10% increase in its quarterly cash dividend today. The new quarterly dividend increases to 22 cents per share versus 20 cents per share in the same quarter last year. The projected payout ratio equals 41% based on November 2008 estimated earnings of $2.11 per share. The historical 5-year average payout ratio equals 38%.

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Freddie Mac Cuts Dividend In Half

The mortgage fiasco hit Freddie Mac (FRE) investors today. The company announced it would pay a fourth quarter dividend of 25 cents per share versus 50 cents per share in the same quarter last year. This 50% cut jeopardizes FRE's listing on Standard & Poor's list of company's' that have increased annual dividends for at least 10 straight years. In addition to the dividend cut, the company announced plans to sell $6 billion of preferred stock in anticipation of more loan losses.

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Dividend Increases Improve Valuation Multiples More Than Share Buybacks

The Boston Consulting Group's 2007 Value Creation Report notes dividend increases do more to increase shareholder value than stock buybacks. The report notes one reason company's use cash to buy back shares is "buybacks boost EPS above the level that underlying organic growth in net income would on its own." The BCG report notes, "that EPS growth is not necessarily a differentiator of multiples. And when it is, investors are extremely sensitive to how the EPS is delivered."

The BCG research demonstrated that:

• dividends have a far more positive impact on a company's valuation multiple than share repurchases do.

• the report also noted that share repurchases actually erodes a company's valuation multiple as detail in the table below.
  

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Source:
Avoiding the Cash Trap
The Boston Consulting Group
By: Eric Olsen, Frank Plaschke, Daniel Stelter
September 2007
http://www.bcg.com/about_bcg/media_center/press_releases.jsp?id=2421

Low Bullish Investor Sentiment

The level of individual bullish investor sentiment as reported by the Association of Individual Investors declined to 25.58% versus the prior week's level of 33.01%. The bull/bear spread widened to -27. This level of bullishness was last achieved in July 2006 when the bullishness level equaled 23.85%. The bull/bear spread at that time was -34.

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Source: American Association of Individual Investors

Modern Portfolio Theory: Is It Over Relied On?

Before I get into the discussion on a recent article that indicates Modern Portfolio Theory (MPT) might not work as many are led to believe, following is a common defintion of MPT:

Introduced by Nobel Prize winner Harry Markowitz in the 1950s, modern portfolio theory proposes that investors may minimize market risk for an expected level of return by constructing a diversified portfolio. Modern portfolio theory emphasizes portfolio diversification over the selection of individual securities. A simplified version of modern portfolio theory is "Don't put your eggs in one basket". Modern portfolio theory established the concept of the "efficient frontier." An efficient portfolio, according to modern portfolio theory, is one that has the lowest risk for a given level of expected return. An underlying concept of modern portfolio theory is that greater risk is associated with higher expected returns. To construct a portfolio consistent with modern portfolio theory, investors must evaluate the correlation between asset classes as well as the risk/return characteristics of each asset.

Many investment advisors present to their clients that MPT minimizes portfolio volatility as ones investment portfolio is allocated to assets less correlated to other assets in their account.

Now onto the discussion on MPT. Recently, SmartMoney featured an article, Modern Portfolio Theory Looks Very Outdated. The article features an interview with Niels Clemen Jensen, a former senior executive at Lehman Brothers (LEH), Goldman Sachs (GS) and Oppenheimer (OPY) who now runs Absolute Return Partners, a $400 million London fund of funds. SmartMoney notes, "Jensen is a pro well versed in the nuts and bolts of modern portfolio theory and risk management. I am here to testify that, in this case, knowledge is not bliss, more like a long leap into the unfathomable."

Following are excerpts from his October 2007 newsletter:

• Here is the problem. Central to all the academic work referred to above is the assumption that returns are normally distributed. If they are not, you might as well bin everything to do with modern portfolio theory. Risk management tools such as volatility, covariance and value-at-risk, all so critical to how we deal with risk, become meaningless if the return pattern does not match the famous bell curve.

• For returns to follow a normal distribution, you must have a set of independently distributed returns with no extremes. You find these mostly in static systems.

• Now, what investors really should worry about is what we call extreme risk – 3-6 SD events which can potentially wipe out years of profits. This is often referred to as fat tail risk. It is to be found to the extreme left of the below chart (encircled in red). However, according to the text book, they do not occur very often. Take a closer look at the following table:

• Statistically, assuming you are not an ‘über human’ vastly outliving the average person on this planet, you should experience only a couple of 2 SD events in a lifetime. The problem is that recent years have been littered with 6, 7 and 8 SD events. A 7 SD event equals 1 every 3 billion years or approximately the lifetime of our planet. Since the 1998 Russian debt crisis, financial markets around the world have experienced at least 10 extreme shocks none of which were supposed to occur more than once every few billion years.

Given these higher standard deviation events AND that returns are not normally distributed, Jensen concludes, "Clearly, the theory doesn’t work in practice and it may be time that we ditch modern portfolio theory altogether. Surprisingly few academic resources have been dedicated to this subject so far."

As one considers building an investment portfolio, they must stick to an investment discipline. Warren Buffett's sage advice, "the most important quality for an investor is temperament, not intellect and "what you need is the temperament to control the urges that get other people into trouble in investing."

More often than not, this means not following the crowd.

Source:

Wagging the Fat Tail (pdf)
The Absolute Return Letter
Absolute Return Partners LLP
By: Niels Clemen Jensen
October 2007
http://www.arpllp.com/core_files/The%20Absolute%20Return%20Letter%201007.pdf

Modern Portfolio Theory Looks Very Outdated
SmartMoney
By: Igor Greenwald
November 20, 2007
http://www.smartmoney.com/invest/markets/modern-portfolio-theory-looks-very-outdated-22165/

Nike And Lancaster Colony Increase Dividend

Both Nike (NKE) and Lancaster Colony (LANC) recently announced dividend increases.

Nike

Last week, Nike (NKE) announced it will increase its quarterly dividend 24.3% to 23 cents per share. This compares to 18.5 cents per share in the same quarter last year. The estimated payout is 28% based on May 2008 estimated earnings of $3.30. The five year historical payout ratio is approximately 19%.

Lancaster Colony

Today, Lancaster Colony (LANC) announced it will increase its quarterly dividend 3.7% to 28 cents per share. This compares to 27 cents per share in the same quarter last year. The projected payout ratio will be 52% based on June 2008 estimated earnings of $2.17. The five year historical payout ratio is 42%.

S&P Adds Site Tracking Home Prices In The U.S.

Standard & Poor's has added a site containing data on home prices in select markets in the U.S. The quarterly information is a summary from the S&P/Case Shiller Home Price Survey.

The purpose is to measure the average change in single-family home prices in a particular geographic market. The monthly indices cover 20 major metropolitan areas, which are also aggregated to form two composites – one an aggregation of 10 of the major metropolitan areas; the other including all 20.

Pre Election Year Stock Market Return: Rally After Thanksgiving?

During pre-election years, the market has tendency to move higher during the last month or so of the year. Chart of the Day provides an update comparing the year to date Dow Jones Industrial Average return versus average pre-election year Dow returns going back to 1900.

• Since 1900, the stock market has tended to outperform during the first six to seven months of the average pre-election year. For the remainder of the year, pre-election performance has tended to be choppy and flat.

• Going forward, the pre-election year has tended to end the year with a small rally beginning around the time of the Thanksgiving holiday.
  

Source: Chart of the Day

Additional election year market information can be found within this blog at the post: The Market and Elections

Earnings Fall Sharply In Q3 For The S&P 500 Index

Operating earnings for the S&P 500 Index declined -8.5% in the third quarter 2007 according to Standard & Poor's. These figures are based on 93% of the companies having reported to date.

• Consumer Discretionary earnings fell 38.9%.

• Financials earnings plunged 33.1%.

• Excluding homebuilders (CTX, DHI, KBH, LEN and PHM) and General Motors (GM), the Consumer Discretionary (8.8% of the S&P 500 Index), would show a 4.2% gain for the Q3 2007.

• Year-over-year quarterly dividends increased 13.3%.

Source:
Q3 Financials Sector Earnings Plunge 33.1%; S&P 500 Earnings Decline 8.48% (pdf)
Standard & Poor's
By: Howard Silverblatt & David R. Guarino
November 15, 2007
http://www2.standardandpoors.com/spf/pdf/index/111507_Q3Earnings.pdf

Another Week And Another Decline In Bullish Sentiment

Individual investor bullish sentiment declines for the third straight week The American Association of Individual Investors reports that bullish sentiment declined to 33.01% versus last week's 36.19%. The 8-period moving average also declined to 42.9% versus 43.6% in the prior week.

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Johnson Controls Increases Dividend 11.1%

Today, Johnson Controls (JCI) announced an 11.1% increase in the company's quarterly dividend. The new quarterly dividend will equal 13 cents per share versus 11 cents per share in the same quarter last year. This increase represents the 33rd consecutive year that JCI has increased its annual dividend. The payout ratio is 21% based on estimated 9/30/2008 earnings of $2.53. This is in line with the 5-year payout ratio of 21%.

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Leggett & Platt, Automatic Data Processing & Harsco Increase Dividend

Today, Leggett & Platt (LEG), Automatic Data Processing (ADP) and Harsco (HSC) announced dividend increases.

Leggett & Platt

The company announced it would be increasing its quarterly dividend nearly 39%. The new quarterly dividend equals 25 cents per share versus 18 cents per share in the same quarter last year. The estimated payout ratio equals approximately 70% based on estimated 2008 earnings of $1.42 versus the 5-year average payout of 52%. It should be noted in the company's news release today, LEG indicated they would be selling about 1/5th of their portfolio of companies. The release stated:

"The company is adopting a new strategic objective, implementing role-based portfolio management and more rigorous strategic planning, and narrowing its focus by eliminating over one-fifth of its portfolio. Leggett also intends to enhance returns on its remaining assets, return more cash to shareholders, and pursue disciplined growth."

Automatic Data Processing

The company announced it would be increasing its quarterly dividend by 26%. The new quarterly dividend equals 29 cents per share versus 23 cents per share in the same quarter last year. The estimated payout ratio equals approximately 53% based on estimated June 2008 earnings of $2.17 versus the 5-year average payout of 44%.

Harsco Corp

Harsco announced it would be increasing its quarterly dividend by 9.9%. The new quarterly dividend equals 19.5 cents per share versus 17.75 cents per share in the same quarter last year. The estimated payout ratio equals approximately 23% based on estimated 2008 earnings of $3.38 versus the 5-year average payout of 39%. It should be noted that Harsco's dividend remained unchanged from the 1st quarter of 1989 through the 4th quarter of 1991. Also, the dividend remained unchanged from the 1st quarter of 1993 through the 4th quarter of 1994.

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Are Retail Stocks Overvalued Or On Sale?

For the past week or so I have intended to post a comment on the retail sector. It looks like Barrons and The Big Picture websites beat me to the punch. I will not restate Barrons or The Big Picture articles. To get a glimpse into the sector, one can read the The Big Picture's article, Are Retailing Stocks Bargains? TBP also provides a link to the article that appears in this week's Barrons

Earlier this week I was conveying a retail story to an associate on the fact my wife received a $25 gift card in the mail from J. Crew (JCG) several weeks earlier. About a week later, the J. Crew store in a mall near us called my wife to remind her of the gift card and that the store would be getting a fresh supply of merchandise the following Monday. Now, if retail business was that good, I do not think the store would be calling potential customers. I actually can't recall this ever happening before. As I finished this story my associate told me he received a similar call from a Jos. A Bank (JOSB) store near where he works. The caller from the store advised him of a sale and new merchandise. Not to be out done, J. Jill, owned by Talbots (TLB), also called my wife to tell her of a sale their store had in progress. Other than the fact my wife is likely doing too much shopping in these store, retail can't be all that good if individual stores are calling potential customers in order to generate sales.

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Based on the below retail sector chart from Bespoke Investment Group, the sector is trading below its long term average sector weighting. Additionally, markets tend to improve six months following a Fed rate cut. It is likely then that certain retail stocks look like somewhat attractive investments at this point.

Source: Bespoke Investment Group

Six months ago , when many retail stocks were trading at 52-week highs, not many analyst were calling for a decline in the retail sector. Now that many of these stocks are down, analyst turn negative on the stocks. From a contrarian perspective, maybe this is a sign of a bottom in the making.

Sysco Corp. Raises Dividend 15.8%

Today Sysco Corp (SYY) announced a 15.5% increase in its quarterly dividend. The new dividend of 22 cents per quarter compares to 19 cents per quarter in the same period last year. As detailed in the company's dividend announcement, Sysco has increased its dividend every year since 1970. It should be noted the projected payout ratio will be 49% based on June 2008 estimated earnings of $1.79. The five year average payout is approximately 40%. The ratio has trended higher in each of the last five years.

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Will This Be A "Growth Recession?"

In the Fall 2007 T. Rowe Price Report newsletter, the firm's chief economist, Alan Levenson, is calling for a "growth recession" as a result of the weak housing market. The article describes a growth recession as one in which:

"output and employment grow, but not quickly enough to prevent the unemployment rate from rising. That would mean real gross domestic product (GDP) growth of roughly 2%, a modest diminution of inflation pressures, and flat corporate profits through the end of 2008."

T. Rowe Price (TROW) believes a second phase of new construction cutbacks will be felt over the next 12 months. A result of these cutbacks will be to:

reduce real GDP growth by roughly 0.6% in the year ending June 2008, compared with a full percentage point drag over the four quarters ended in June 2007.

If T. Rowe Price's economist is correct, there will likely be more equity volatilty in the near term.

Source:

A "Growth Recession" Likely Fallout of Credit Downturn (pdf)
T. Rowe Price Report
By: Alan Levenson
Fall 2007
http://www.troweprice.com/gcFiles/pdf/04779-Fall-yr07_final.pdf?scn=2007&rfpgid=7949&ft=GNL_CTT

Bullish Sentiment Declines This Week

What a difference a week makes. The bullish sentiment reading from the American Association of Individual Investors Sentiment Survey saw a decline to 36.19% versus last week's reading of 44.71%. Additionally, the bearish reading jump to 51.43% versus the prior week reading of 36.47%. This is the highest reported level for the bearish reading since May 2007. Keep in mind this sentiment indicator is viewed from a contrarian perspective.

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Data Source: American Association of Individual Investors

Emerson Electric Increases Dividend 14%

Today Emerson Electric Co. (EMR) announced a 14% increase in the company's quarterly dividend. The new quarterly dividend increases to 30 cents per share versus 26.25 cents per share in the same quarter last year. The projected payout ratio is approximately 40% based on 2008 year end estimated earnings of $2.98. The 5-year payout ratio is approximately 54%.

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Supreme Court Hears Oral Arguments in Kentucky v. Davis Municipal Bond Case

The Supreme Court heard oral arguments today in the Commonwealth of Kentucky vs. Davis municipal bond case today. Media reports indicate the justices are leaning towards not disrupting a state's right to tax out of state municipal bond interest. According to The Wall Street Journal:

Justice David Souter was also critical of the challenge and worried aloud about disrupting the municipal bond market. "We have an enormous market, the effect of interrupting which we really as a court cannot tell very much (emphasis added)," Justice Souter said.

Bloomberg led with a story, Muni Bond Tax Breaks Get Support From U.S. Justices. In the article it was noted that:

Samuel Alito questioned whether states should be allowed to give special tax breaks on bonds that finance private construction, rather than a government project. So-called private activity bonds finance mortgages, student loans, small-scale industrial projects and redevelopments.

The bond market will certainly be on the edge awaiting a decision from the Court.

Source:
Supreme Court Hears Challenge To Muni-Bond Tax Exemption
The Wall Street Journal Online
By: Mark H. Anderson
November 5, 2007
http://online.wsj.com/article/SB119426995434382472.html?mod=djemTEW

Muni Bond Tax Breaks Get Support From U.S. Justices
Bloomberg.com
By: Greg Stohr
November 5, 2007
http://www.bloomberg.com/apps/news?pid=20602007&sid=arBGoFUAegdE&refer=rates

Dividend Payers Underperform Non-Payers In October

The dividend paying stocks in the S&P 500 Index underperformed their non-paying counterparts in the month of October. The payers October monthly return equaled 2.34% versus the non-payers return of 2.84%. On a year to date basis, the payers lagged the non-payers as well, 6.01% versus 7.13%, respectively. A large part of the underformance can be attributed to the weak results from the financial sector. The financial sector weighting in the S&P 500 is nearly 19% of the index. During October the financial sector declined -1.99% versus an overall index return of 1.48%.

Additional information on the index performance for October can be found under Standard & Poor's MarketAttributes section of their website.

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Source: Standard & Poor's

Bullish Sentiment On A Roller Coaster

The often volatile contrarian individual investor bullish sentiment reading does not surprise this week. The American Association of Individual Investors reported bullish sentiment jumped to 44.71% versus last week's bullishness reading of 31.25%. In an effort to smooth out this volatility from week to week, the below chart contains the 8-period moving average of the bullish indicator. This indicator also saw an increase to 44.1% versus 43.3% in the prior week.

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Data Source: American Association of Individual Investors