Will This Be A Buy The Dip Type Market For Stocks?

October was certainly a good one for the U.S. equity markets in spite of the 276 point decline today. The Dow Jones Industrial Average increased more than 1,000 points in the month returning 9.5%. The S&P 500 Index increased 10.8% in the month and was the best return since December 1991. A 3-5% pullback certainly would not be surprising given the strength of the advance in October. Will investor then buy into this pullback? I believe they will. One key will likely be the ability of the market to find support around the 200 day moving average of 1,274.

From The Blog of HORAN Capital Advisors

From a fundamental perspective, valuations and earnings for companies in the S&P 500 Index in Q3 are coming in at a respectable level. Of the 315 companies that have reported results for Q3, 71% have reported earnings above analyst expectations and this is higher than the long term average. Importantly to, revenue growth has growth has exceeded expectations as well.

Almost two years ago, I wrote a post that focused on indicators investors might evaluate to determine the future direction of the economy. Following is an update on several of those indicators and they do suggest the economy is not going to dip into another recession.

Durable Goods Orders

• a positive trend continues in durable goods orders since the recession end in 2009.
  

From The Blog of HORAN Capital Advisors

Jobless Claims

• jobless claims remain stuck above 400,000; however, they are trending lower. This is indicative of of a slow growth economy. The initial report for Q3 GDP was growth at 2.5%.
  

From The Blog of HORAN Capital Advisors

Retail Sales

• strength in retail sales continues to surprise on the upside.
  

From The Blog of HORAN Capital Advisors

Chicago PMI

• the Chicago ISM-Purchasing Managers Index came in below expectations today; however, the reading remains above 50 indicating an expansionary environment.
  

From The Blog of HORAN Capital Advisors

Consumer Confidence

• an area of concern is the confidence level of consumers and businesses. The lack of business confidence was highlighted in the Chicago Purchasing Managers release today. Businesses have concerns above the strength of the economy going into 2012. As the below chart shows, consumer confidence (blue line) is trending lower as well. This lack of confidence on the part of both businesses and consumers will likely constrain economic growth and result in a slow growth environment through the election in 2012.
  

From The Blog of HORAN Capital Advisors

Looking to the end of the year, volatility will likely be the norm. Washington, D.C.'s so-called Gang of 12 needs to come up with a "credible" deficit reduction plan. With the U.S. dealing with its debt issues along with the EU's sovereign debt issues, the cure for dealing with over leverage will likely be slower economic growth, but growth nonetheless. These issues alone will influence market action in the short term. Company fundamentals though look to be good and fundamentals tend to drive long term investment returns.

Is The Steep Contraction In The China 25 Stock Index A Red Flag?

For some perspective on one of the more important global stock markets, today's chart focuses on Chinese stocks and presents the current trend of the iShares FTSE/Xinhua China 25 Index (FXI). As today's chart illustrates, Chinese stocks have endured what amounts to an extremely wild ride since 2005. The FXI trended upward at an ever accelerating rate (i.e. parabolic) from 2005 to Q4 2007. As the credit bubble began to unravel, so too did Chinese stocks with the FXI trending downward at an ever accelerating rate from Q4 2007 to Q4 2008. Beginning in Q4 2008, the FXI surged -- gaining over 155% trough to peak. Since that post-financial crisis peak back in Q4 2010, Chinese stocks initially treaded water but more recently have entered in to a steep downward trend channel. Considering China's increasingly significant contribution to the global economy, this recent stock market action is most definitely a red flag.

From The Blog of HORAN Capital Advisors

Source: Chart of the Day

Third Quarter 2011 Investor Letter

Correlations were high in the strongly negative performing third quarter for most equity markets. So far in October though, the market has rallied strongly off the lows resulting in one of the best performing Octobers since 2000 with one week remaining. Europe's efforts to come up with a solution to their sovereign debt issues and Washington's Deficit Panel or Gang of 12 outcome could create headwinds for the market. Our 3rd Quarter Investor Letter contains our prospective views on the market for the balance of the year and into 2012.

HORAN Capital Advisors' complete Investor Letter can be accessed at the following link: 3rd Quarter Investor Letter

Deficit, Debt And Law Of Large Numbers

This evening I had a conversation with an individual whose career is working as an economist. The discussion topic focused on taxes and the deficit. He was adamant that the risk for the U.S. was centered around the "law of large numbers" as it relates to this countries debt level.

This brought to mind the article post written by Terry Horan, the CEO of our business partner firm HORAN Associates, on his blog today, Parties in the Park and Dancing in the Dark. In his post he discusses the 99 Percenters argument that they believe the system is rigged, they are not getting a fair shake and it is time for change.

In Terry's post he shows the below table of federal tax receipts, spending and the government deficit, which was detailed in a recent Wall Street Journal article. In the table the deficit is also shown as a percentage of GDP. What stands out is the growth in the deficit due mostly to an increase in spending. Tax receipts for 2011 are higher than 2010 and 2010 is higher than 2009. For 2011 personal income tax collections were higher by 21%!

Also reported by the Wall Street Journal, "revenue rose 6.5% billion to $2.3 trillion, the equivalent of 15.4% of gross domestic product, largely due to higher income-tax receipts in fiscal 2011, the Treasury said. Spending climbed 4.2% to $3.6 trillion, or 24.1% of GDP, largely due to higher spending on interest, Medicare and Social Security. Thirty six cents of every dollar spent by the federal government in fiscal 2011 was borrowed (emphasis added).

The fallacy of showing the deficit as a percentage of GDP is, at some point, the debt grows to a level where it can't be repaid within any reasonable time if at all. Or, in looking at Greece, there are no buyers of the debt. For the U.S., it's buyer is China.

What makes the discussion about our $14 trillion debt difficult for the average person to comprehend is the absolute size of the number where billions and trillions simply do not seem like real numbers--the "law of large numbers". A recent article at the American Thinker website, The National Debt is Beyond Our Comprehension, attempts to put the amount into perspective.

"We can probably get our minds around a million dollars, but beyond that the numbers become mere abstractions. They simply cease to be real. They are not real, because we really cannot visualize them in a meaningful way. We may have gotten used to hearing about billions, but trillions are really beyond our mental grasp. How many of us, for example, can state the number of zeros in a trillion without having to count them? There are twelve. Now try to mentally visualize the number one trillion. Can you do it? Can you really see a "1" followed by twelve zeros in your mind? I can visualize a billion, but that is only nine zeros: three groups of three. It takes some effort to mentally see four groups of three zeros.

Suppose someone was going to give you $1 every second of every minute, of every hour, of every day without stopping. How long would it take them to give you $1 trillion? Well, let's see. There are 60 seconds in a minute, so that is $60 every minute. Then there are 60 minutes in every hour, so that means we would receive $3,600 every hour. Wow! Even my plumber doesn't charge that much. In a single day, therefore, you would receive $86,400. Most people don't get that much in a year.

Since there are 365¼ days in a year, at the rate of $1 per second the pile of dollar bills would amount to only $31,557,600. Now we are talking real money. That is a lottery jackpot most of us would love to win. But that is still just a number in the low millions.

So, at a dollar a second how long would we have to wait before we could see the pile grow to $1 trillion? Are you ready for the answer? Drum roll, please. It would take over 31,688 years. Even at $10 per second they would still have to have started handing you the money more than a thousand years before the birth of Christ! And even at $100 per second none of us could live long enough to get it all.

At $100 per second we are still only talking about $8,640,000 a day. So in a year you would have accumulated only a little over $3 billion. It will take more than 316 years to reach $1 trillion.

A trillion dollars is so much money that you and I would probably not be able to spend that much for ourselves unless we bought a small country somewhere. Most of us would have trouble trying to spend a billion dollars, and a trillion is a thousand billion. So, if the government wants to reduce the deficit by a trillion dollars, it would have to do the equivalent of cutting a billion dollars from each of one thousand government programs...

The frightening truth is that Congress cannot easily cut $1 trillion from the deficit. The reality is that if you gave a new congressman on his first day on the job a copy of the budget, and told him to cut $10,000 from the budget every second of every day nonstop, his term in Congress would be up before he had cut out $1 trillion."

As much as the government would like taxpayers to pay more into the treasury, the real answer is spending cuts need to be the primary focus immediately. This is something the Deficit Panel or so-called Gang of 12 committee in Washington is having difficulty agreeing on.

S&P 500 Buybacks Over $100 Billion in 2nd Quarter

Preliminary buyback data released by Standard and Poor's indicates S&P 500 companies bought back $109 billion of their stock in the second quarter. This is the first time buybacks have exceeded $100 billion since the first quarter of 2008 when buybacks totaled $113 billion. On a year over year basis, the Q2 buyback amount was 41% higher than the buyback total in Q2 2010.

Howard Silverblatt of S&P notes,

"At this point, companies are continuing to use buybacks to prevent earnings dilution from employee options, as well as shares used for dividend reinvestment programs. Few companies are venturing outside of the box to purchase additional shares, as was the common practice from late 2005 through mid-2007."

Silverblatt goes on to note,

"Exxon Mobil's buybacks have reduced its share count by 18.5% over the past five years ($129 billion), which may cost it its position as the largest company in the world."

From The Blog of HORAN Capital Advisors

Data source: Standard & Poor's

Interestingly, as the box in the chart details, the cumulative earnings generated by the companies in the S&P 500 Index since 2001 have been returned to shareholders either in the form of a dividend or stock buybacks.

Companies Buying Back Shares Are Outperforming

It has been some time since I last reported on the performance of companies that buyback their own equity shares. With a number of companies sitting on large amounts of cash and announcing share buybacks, including Berkshire Hathaway (BRK.A), one way to track the performance of companies buying back shares is to review the performance of the PowerShares Buyback Achievers Portfolio (PKW). The PowerShares Buyback Achievers Portfolio will normally invest at least 90% of its total assets in common stocks that comprise the Share BuyBack Achievers™ Index.

The PowerShares Buyback Achievers Portfolio is based on the Share BuyBack Achievers™ Index. To become eligible for inclusion in the Index, a company must be incorporated in the U.S., trade on a U.S. exchange and must have repurchased at least 5% or more of its outstanding shares for the trailing 12 months.The Share Buyback Achievers™ Index is a trademark of Mergent® and currently consists of 142 companies.

As the below chart and table detail, the Buyback Portfolio (PKW) has a recent history of outperforming the broader market S&P 500 Index. Over the last two years ending 9/30/2011, PKW has generated a return of 21.87% versus the broader market S&P 500 Index return of 7.03%.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Investors should be aware of the fact that the Buyback Achievers Portfolio does contain sector concentrations. Additionally, the Portfolio does not contain any energy stocks at this time.

From The Blog of HORAN Capital Advisors

The top 10 holdings in the Index are:

From The Blog of HORAN Capital Advisors