Investors who stuck with equity investments (S&P 500 Index) in October 2008 and through the March 2009 sell off would now be up 9% from October 2008 through August 2009. Many investors liquidated equity investments in October and again in March.
Investors withdrew $70 billion from the stock market in October 2008 and another $50 billion in the February/March 2009 period.
As of October 16, 2009, one year after the peak in liquidations, investors who remained in the stock market had fared better than those who exited at the peak of the crisis and stayed on the sidelines.
One implication for investors as it relates to this data is the difficulty in trying to time the market. For investors, focusing on high quality dividend growth stocks provides the potential to minimize the downside volatility in the equity portion of ones portfolio.
Source:
Stay-the-Course Ahead of Panic Sellers By: Fidelity's Market Analysis, Research, & Education Group October 23, 2009 http://publications.fidelity.com/investorsWeekly/investorsWeekly/cms/IW0910crisis.dyn
As readers may have noticed from the limited number of posts to my blog this week, I was away from the computer due to some out of town travel. I traveled by car from Ohio to Florida on I-75. Along with my travel companion, we both commented on the number of semi trucks that were traveling the highway. The parking lots at a couple of truck stops we passed were packed full with semis. Even several of the rest areas were packed with semis. I am guessing all these trucks were not traveling with empty loads. At a minimum, I think the economy is experiencing some inventory restocking activity and possibly a pick up in consumer demand.
As I have noted in several earlier posts, Congress is looking to place a tax on stock trades. They have not given up on this trading tax as noted by the below screen shot from my Site Meter account.
Investors are often advised to spread their investments across differing asset classes because of the lower correlation of these other asset classes. Unfortunately, the correlation of many of these other asset classes has continued to increase.
I have discussed this issue of higher correlation in earlier posts:
Fidelity's Market Analysis, Research and Education (MARE) group recently updated correlation data as of August 31, 2009. As the below table notes, correlation versus the S&P 500 Index has increased across a number of asset classes except U.S. Government Bonds.
MARE notes the potential investment implications:
U.S. government bonds performed very well as riskier assets tumbled during the financial crisis in 2008, but so far in 2009 have fared poorly as riskier assets have rallied amid signs of economic stabilization and improvement.
There are potential scenarios where U.S. bonds could either hold up well in the months ahead (a double-dip recession, further financial system turmoil, etc.) or underperform riskier assets (rising inflation, increased concerns about the U.S. fiscal deficit/creditworthiness, or a better-than-expected economic recovery).
It remains to be seen whether the recent increase in correlations among riskier assets will define a new, more highly correlated era. In any case, investors are likely to be on safer ground anticipating that U.S. government bonds will continue to be one of the few ways to effectively diversify a portfolio.
In the end, investors need to be aware of this move towards higher correlation across a number of asset classes. Simply spreading ones investments into various asset classes will not necessarily ensure a higher risk adjusted return.
This week's sentiment survey by the American Association of Individual Investors saw bullish investor sentiment jump by 12.21 percentage points. The bull/bear spread was reported at +14 versus -6 last week. These weekly measures are volatile and looking at the 8-week moving average smooths out this variability. The 8 week average increased to 39.56% compared to 37.90% last week.
The bullishness reading is a contrarian indicator and a continued increase in individual investor bullishness would be one signal the market could be approaching at least a short term top.
When determining the future direction of the market, many investors and strategist turn to the price to earnings ratio. One key to using the P/E ratio is the calculation of earnings. Earnings are reported in several forms, one being "reported earnings" and the other referred to as "normalized" earnings. One significant point made in the article is the justification of using normalized earnings. Easterling notes,
"...if you only look at the P/E ratio reported for any quarter or year, the ratio during peaks and troughs will be quite distorted when compared to the more stable long-term average. About every five years or so, the reported P/E will reflect the opposite signal in contrast to a more rational view of P/E valuations. For example, the reported value for P/E in early 2003 reflected a fairly high value of 32 just as the S&P 500 Index had plunged to 800 (E had cycled to a trough of $25 per share). A P/E of 32 generally screams “sell” to most investment professionals; yet, in early 2003, that was a false signal! A more rational view using one of the business cycle-adjusted methods reflected a more modest 18. In a relatively low inflation and low interest rate environment, the scream should have been “Buy”…
Several years later, in 2006 (after an unusually-strong run in earnings growth), E peaked at $82 per share as the S&P 500 Index was hesitating at 1500. Most market pundits were recommending a strong “buy” due to a calculated P/E of only 17. Yet, using the rational business cycle-adjusted methodologies, the true message was “STOP”—P/Es were saying sell, with P/E more than 25.
Well the pundits were actually (sort of) right—P/Es did expand… Yet it was due to (what should have been expected) the normal down-cycle in E rather than the pundit-promoted increase in the stock market. So when investors’ stock market accounts were down almost 50%, they were handed explanations that the earnings decline was unexpected and the fault of the financial sector…
Many of the same pundits are bewildered by current market conditions and unsure about the future of E. The latest craze to extrapolate current conditions into the indefinite future has been named “The New Normal.” Slow economic growth, high saving rates, and unstable financial conditions—all fairly typical at the end of a recession—are now basic assumptions for years into the recovery expansion. Maybe this time will actually be different…or maybe not…
As for the market and P/E, it’s understandable that conservative investors and market spectators have watched the past six-month rally with awe. Yet the current P/E remains slightly undervalued and further gains are more likely; nonetheless, it is important to remain aware that typical market volatility makes it also likely that the market will experience significant short-term swings."
Ed Easterling of Crestmont Research provides an update on the market valuation in his quarterly P/E Report. The most recent report is detailed below and is a worthwhile reading. Beginning on page 4 of the report, he goes through his analysis of the potential target on the market (see Figure 6 on page 12.) Not that the market will go up in a straight line, but he does build a case for a 3-year target price on the S&P 500 Index of 1,685. The earnings figure utilized in the target is a normalized one that has been adjusted for inflation. A similar inflation adjusted valuation measure is used by Robert Shiller of Yale University.
The article's conclusion is the market remains in a secular bear market while still undervalued. As Crestmont has noted before, cyclical bull markets are common in longer term or secular bear market periods. Crestmont updates a table noting prior bear and bull market cylces.
For investors, inflation is a critical variable that will impact the value of the market. Staying abreast of inflation data points will provide some insight into the markets future direction. The advance from the market's March low has been impressive. Today's move above 10,000 on the Dow and 1,090 on the S&P 500 index was important from a technical point of view. Interestingly, the volume today was better than what we have seen of late, which is good, but the volume level is not what one would see at capitulation buying points. This is only "one" technical factor, but it would suggest the market could still move higher as some investors are in disbelief that the market has not had a significant correction that would consolidate the gains since March.
Over the past month, investor bullish sentiment has continued to trend lower as measured by the 8-period moving average of the bullish sentiment reading. Last week's bullishness reading of 35.09% feel below the long term average of 38.94% as reported by the American Association of Individual Investors. Additionally, last week's reading was nearly 8.5 percentage points lower than the bullishness reading in the prior week. The bull/bear spread was -6% versus +8% last week.
This has been a year that the old adages like "Sell in May and Go Away" or September is the worst month for market performance did not hold true. Some attribute this to the fact the market simply overshot on the downside in March.
In line with these adages, the market's performance in the year following big down years has generally been strong. Courtesy of Chart of the Day, the following chart notes the market's performance tends to be strong in those years following the years where the market declined significantly. As the chart notes, the exceptions were the early 1930's and 1978.
The below chart presents the performance of the Dow for the calendar year following the 15 worst calendar year performances of the Dow since 1896. The Dow's performance during the 2008 calendar year was the third worst on record. Could there be more upside to the market as we move into the end of this year?
For the 36th consecutive year, RPM International (RPM) announces a YOY increase in its quarterly dividend to 20.5 cents per share. This compares to a quarterly dividend of 20 cents per share in the same period last year: a 2.5% increase.
The estimated payout ratio is 65% based on May 2010 estimated earnings of $1.26. May 2011 earnings are estimated at $1.50. RPM earnings have been impacted by the economic slowdown resulting in payouts of 80%, 176% and 38% over the course of the last three years. RPM carries an Earnings and Dividend Quality Ranking of B.
J. Kyle Bass and his firm made billions shorting subprime mortgages prior to the mortgage meltdown. The below third quarter newsletter provides perspective on current monetary policy around the world. The newsletter contains an in depth discussion on China, Japan and the timing of potential inflation. The commentary is a must read for investors.
I had a reader (H/T br) send me a scatter chart of Tobin's q and the S&P 500 Index. The data period is 1950-1999. I added a line estimating where the second quarter ratio would fall at .78. tobins q & S&P 500
Another chart sent by the reader contains a scatter chart of the S&P 500 Index's future 10-year annualized return versus the inflation adjusted 10-year average P/E ratio. This data was obtained from Robert Shiller's data base (.xls file). S&P 500 Return and PE Scatter Chart
As of the end of September, the return for the dividend payers in the S&P 500 Index continues to badly trail the return of the non payers. On a year to date basis, the payers' return equals 17.55% versus the non payers' return of 56.70%. The strongest performing stocks have been the lower quality ones and these tend to not pay dividends.
(click to enlarge)
Howard Silverblatt noted in a Dow Jones News Wire release:
In the third quarter, of about 7,000 U.S-traded companies, 191 increased their dividend for the period, down from 346 a year earlier and 439 in 2007. In contrast, 113 companies lowered their dividend payment during the quarter, down from 138 in 2008 but up from just 21 in 2007.
Howard Silverblatt said the third-quarter figures suggested that dividends may have finally hit a bottom. But he warned it may take several quarters of proven results for companies to be comfortable with increasing, or initiating dividends. Even then, Silverblatt said the level will likely be more subdued than what was seen two years ago.
According to Silverblatt, dividend increases have outnumbered cuts every year since 1955, with the average being 15 increases for every decrease. So far this year, the relationship is almost even, with increases at 707 and decreases at 730.
Argus Research performed a back-of-the-envelope value of Tobin’s ‘q’ – which is a measure of market valuation. This is based on the Federal Reserve's recently released quarterly Flow of Funds data for the second quarter of 2009.
"Investors will recall that 'q' is defined as the ratio of the market value of a firm to the replacement cost of its assets; in this case we are estimating those figures for the entire industry. According to Nobel Laureate James Tobin, the ratio of total stock market value to the stock market’s net worth (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, or cheaper to buy than build. This discount possesses 'q' ratios that are less than 1.0. Conversely, when 'q' exceeds 1.0, the market trades at a premium to its replacement cost. The run-up from 1996-2000 had 'q' approaching the unthinkable value of 2.0. The most recent (QII 2009) level of 0.78 is notably higher than the 0.65 posting in the first quarter, which was the lowest since QIV 1990."
The below chart speaks for itself when it comes to the relationship between government spending and inflation. It appears the inflation threat is not a matter of if, but when. Government spending is now 25% of GDP and higher interest rates will certainly have a negative impact on the government's future outlays as it likely pays a higher level of interest on the debt.
Consuelo Mack of WealthTrack interviewed the following individuals on Friday:
Michael Hartnett, Chief Global Equity Strategist at BAS-Merrill Lynch
David Winter, portfolio manager of the Wintergreen Funds
Whitney Tilson of the Tilson Mutual Funds
In the interview Consuelo conducted with the three individuals, she obtains their views on the various markets and types of stocks one might consider investing in at this point in the market cycle. A couple of the interview highlights suggest that:
investor need to look more towards individual companies when selecting investments. In short, the easy money has been made with the market rise off of the March lows.
the interview quests suggest investors should look at the emerging markets for future growth opportunities.
Investor enthusiasm remains in check as bullish sentiment fell slightly last week to 39.09% versus the prior week's reading of 42.14%. This is in line with the long term average of the bullish sentiment reading of 39%. The 8-period moving average also declined to 40.70% versus last week's level of 41.77%. The bull/bear spread became more negative with a reading of -5% versus +2% last week.
The sell off in the market towards the end of this week has been occurring on lower volume. The market seems to be working in a healthy consolidation similar to the consolidations in the middle and end of August.
As I have noted in prior posts, the below chart was first publish in 1991 by technical analyst Justin Mamis in a book titled The Nature of Risk. I believe we are still in the "denial" phase of the market and have yet to see returning confidence that might present itself as capitulation buying.
Certainly today's economic reports were mixed. Of interest was the Michigan Sentiment Index that came in at a better than expected 73.5. The estimate was 70.5. Returning consumer confidence is critical since the consumer accounts for 70% of GDP. Later this weekend I hope to post a summary of recently released economic data.
In a recent article in T. Rowe Price's Investor Magazine, it is noted that the market generates a large portion of its return in advance of the economic data confirming the end of a recession. The below table shows some of the prior recessions and the market's return from the recession low after six months and the market's return from the recession low after twelve months.
It seems the most frequent comment I receive of late is "the market is due for a pullback" or something along those lines. If you are a contrarian, this is good. The more investors are skeptical of the advance, the more likely it could move higher. However, as the below chart shows, this advance looks like it could or should be topping out.
(click to enlarge)
Since the March 9th closing low of 677 for the S&P 500 Index, the market has advanced nearly 58% to Friday's close of 1,068. No wonder investors believe we need some market consolidation.
A few technical thoughts on the above chart.
Over 92% of stocks are trading above their 50-day moving average (see white circles at top of chart). The same can be said for the 200-day moving average. This type of chart pattern played out in the April/May period earlier this year. However, the April/May period was one where we saw increasingly lower volume. Today, we are seeing this high moving average percentage, but it is occurring on increasingly higher volume.
In addition to the high percentage of individual stocks trading above their 50 and 200 day moving averages, the S&P 500 Index is significantly above its 200 day moving average. Bespoke Investment Group notes the S&P is trading 20% above its 200-day moving average and this has not occurred since May of 1983.
From a valuation perspective, the market does not seem over or undervalued. The below chart is the P/E of the S&P 500 Index using average inflation adjusted earnings from the past ten years.
The MACD, both the slow and fast moving average lines are in a downtrend. This could signal market weakness in the near term. Offsetting this concern is the market's recent move higher has occurred on higher volume.
It is positive to see higher volume, but this past week was a quadruple option expiration one. This expiration day likely influenced the volume for the week. Also, higher volume could be an indication of capitulation buying by investors that have felt left behind given their high cash levels. Volume in the 8 billion range would be more of the capitulation concern and recent weeks have seen volume below 6 billion.
Are some market strategist that were once bearish now turning bullish? James Grant, editor of Grant's Interest Rate Observer, wrote an article in Saturday's Wall Street Journal titled, From Bear to Bull. He notes in the opening paragraphs of the article:
"As if they really knew, leading economists predict that recovery from our Great Recession will be plodding, gray and jobless. But they don't know, and can't. The future is unfathomable.
Not famously a glass half-full kind of fellow (emphasis added), I am about to propose that the recovery will be a bit of a barn burner. Not that I can really know, either, the future being what it is. However, though I can't predict, I can guess. No, not "guess." Let us say infer."
The entire article by James Grant is a worthwhile read. The below video is an interview with Grant on CNBC in June. A lot of the discussion surrounds the Fed, but the market tone is negative.
So in the end, there is a great deal of conflicting data regarding the sustainability of this market move higher which can be a positive from a market perspective. There are investment opportunities in this climate, but making money in them will not be as easy as it would have been by investing in March.
