Investor Letter July 2012

The market’s pattern YTD in 2012 resembles the market’s action in 2011 while a number of key issues continue to hang over the financial markets. In our second quarter 2011 Investor Letter, we discussed the debt ceiling debate in Washington and Standard & Poor’s subsequent negative outlook and downgrade of U.S. government debt. We also wrote about serious weather related issues that greatly influenced the commodity markets. As was the case last summer, the Euro Zone crisis continues to be an issue as many of the southern European countries attempt to get their fiscal houses in order. As Yankee great, Yogi Berra, once said, “It’s déjà vu all over again.” The most pressing current policy issue is the need for Congress to address raising the U.S. debt ceiling. Similar to last year, the debt ceiling is expected to be reached in early September. It’s not surprising that investor confidence is fragile and waning with multiple unresolved issues.

Our newsletter covers recent impacting the the investment markets.

The Letter can be accessed directly from our website at the following link: 2nd Quarter 2012 Investor Letter

From The Blog of HORAN Capital Advisors

We hope you find the content of our letter insightful as 2012 continues to unfold.

A Repeat Of History?

The market’s pattern year to date in 2012 resembles the market’s action in 2011. A number of the issues impacting the market this year are similar to those that impacted the markets in 2011. Last year investors had to digest the impact of the debt ceiling debate in Washington and S&P placing the government’s debt on negative watch (and subsequently issuing a one notch downgrade), weather related issues influenced commodity markets with flooding in a number of countries around the globe, including in the Midwest of the U.S. and wildfire and droughts impacted the southwestern and southeastern parts of the U.S. These events are again top of mind for investors this year.

From The Blog of HORAN Capital Advisors

The policy issue at the forefront of investors' minds is the need for Congress to take action on raising the U.S. debt ceiling. The debt ceiling is expected to be reached in early September and the debate around this issue will certainly impact individual investor and business confidence. Couple the debt ceiling debate with the upcoming presidential election and the “fiscal cliff” at the end of the year, it is not surprising sentiment and investor confidence is waning.

Large Decline In Individual Investor Bullish Sentiment

The American Association of Individual Investors reported investor bullish sentiment fell over eight percentage points this week. The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months. The bullish sentiment reading of 22.19% was the lowest level since August 26, 2010 when the bullish reading was reported at 20.74%. In August of 2010 the S&P 500 Index was trading at 1,055.33. In the subsequent 12-months, the S&P rose 9.8% to 1,159.27. This one behavioral measures tends to be a contrarian indicator.

From The Blog of HORAN Capital Advisors

 Maybe this reduced bullish sentiment is warranted given the uncertainty surrounding economic growth or lack there of. Yesterday The Conference board reported the Leading Economic index declined .31% in the month of June. This was the second decline in the last three months. The Conference Board noted, "The strengths among the leading indicators have become less widespread as consumer expectations and manufacturing new orders offset gains in the financial, labor, and construction-related components. Meanwhile, the coincident economic index, a measure of current economic conditions, has risen slowly but steadily in the last three months.” The report goes on to note, “The U.S. economy is growing very slowly. The CEI basically reflects this steady but soft pace of overall economic activity. The LEI is pointing to no strengthening over the next few months, as the economy continues to sail through strong headwinds domestically and internationally.”

From The Blog of HORAN Capital Advisors

Mega Cap Stocks May Be Poised To Outperform

The market's recent pullback certainly seems warranted given the lack of positive news flow both economically and fundamentally. The euro zone continues to struggle in dealing with its debt issues, corporate earnings reports for the second quarter have been less than exciting and policy uncertainty out of Washington is weighing negatively on consumer and business sentiment. This seems like a replay of last year. In spite of these headwinds the S&P 500 Index remains higher on the year by 7.9%. From a pure technical standpoint, the S&P 500 Index does remain in a short term uptrend beginning in early June but in a downtrend since May as noted in the below chart. There is resistance at the 1,374 level and support at the 50 day moving average of 1,335. Additionally, the recent decline has not occurred on large volume.

From The Blog of HORAN Capital Advisors

Caution does seem warranted for a number of reasons as outlined in earlier posts. However, when the market does begin to rally it could be mega cap stocks that lead the market higher. A recent Fidelity report, "Capitalizing on Inefficiences in Mega Cap Equities," highlights some positive attributes of these larger cap equities. In evaluating mega cap stocks, Fidelity used the 200 largest stocks in the Russell 1000 Index. On a relative valuation basis, compared to the other 800 stocks in the Russell 1000 Index, the mega cap stocks are trading at a 26% discount to the midcap stocks of the Russell 1000 Index.

From The Blog of HORAN Capital Advisors

On a P/E basis the mega caps are trading at valuation levels last seen in late 1991. Further, on a forward P/E basis, mega caps appear more attractive than their midcap counterparts.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

In looking at performance, mega cap performance has trailed significantly versus the midcap stocks.

From The Blog of HORAN Capital Advisors

And lastly, investors receive attractive dividend yields from these 200 mega cap holdings. The mega caps are yielding over 4% while the mid cap stocks yield just under 2.5%.

Volatility in the equity market seems more the norm today; however, investors seeking equity exposure might find an opportunity in these larger capitalization stocks. In Fidelity's report they evaluated the top 50 mutual funds and found the mega cap stocks were consistently under owned by most active managers.

Source:

Capitalizing on Inefficiences in Mega Cap Equities
Fidelity Investment Insights
By: Matthew Fruhan, Naveed Rahman, Alex Devereaux
June 2012
https://www.fidelity.com

Obama's Tax Platform Putting Retirees At Risk?

The current low level of CD and bond interest rates has resulted in retirees allocating more of their investment dollars to higher yielding equity and lower quality bond investments. President Obama's pledge to increase taxes on the rich ($250,000 and above in income) will likely have a negative impact on retiree incomes after 2012.

• The 2013 top marginal rate for qualified dividends increases from 15% to 44.6%.
• The tax on interest, rents, royalties, etc., increases from 35% to 44.6%.
• Long term capital gain tax increases form 15% to 25%.

These tax increases, with no commensurate proposal to reign in government spending, will have a detrimental impact on economic growth in the U.S. said Josh Brown, vice president of Fusion Analytics and author of The Reformed Broker blog.

A detailed summary of the tax implications of the Affordable Care Act can be found on the Association For Advanced Life Underwriting website.

Issues To Impact The Market In Second Half Of 2012

Investors and consumers will face a number of key issues in the second half of 2012 that are likely to impact their confidence level due to the influence these issues will have on the markets. One impact is potentially higher equity market volatility and this will not be a positive to investor confidence. Some of the issues and the respective dates investors need to keep an eye on are:

• September 2012: Debt Ceiling Debate: The market's response to the debt ceiling debate last year: it started a six week decline following S&P's downgrade of the credit rating for the U.S. President Obama has stated to Congress July 22 is the deadline for coming to an agreement to increase the debt ceiling by $2 trillion. The news flow resulting from this issue will likely have an impact on the market and influence investor confidence. The debt ceiling is expected to be reached in early September.

From The Blog of HORAN Capital Advisors

Source: The Big Picture

• November 2012, U.S. Elections: The political rhetoric will undoubtedly be raised to a heightened level as the November elections approach. Historically, the equity market is stronger in the second half of a presidential election year. Given the many issues that will need to be addressed in the balance of the year, it remains to be seen whether the market can move higher in the face of these hurdles. Also, the lame duck session of Congress could lead to market moving headlines.

From The Blog of HORAN Capital Advisors

Source: T. Rowe Price

• December 2012, Fiscal Cliff: The fiscal cliff is in reference to the expiration of the so-called Bush tax cuts, expiration of the payroll tax cut, the implementation of automatic spending cuts and the initiation of additional taxes to support the new healthcare law, all beginning in 2013. This fiscal cliff is as much as 3.9% of GDP and is likely to have a negative impact on economic growth in the U.S. The below table outlines various scenarios that could play out through 2015 and the resulting impact on GDP.

From The Blog of HORAN Capital Advisors

• December 2012, The End of Operation Twist: The Fed recently stated they will maintain Operation Twist through the end of this year. Although this liquidity program really artificially impacts the market, past Federal Reserve actions have tended to support higher equity market returns. Interestingly, each subsequent liquidity action by the Fed is having a smaller positive impact on equity market returns. The culmination of this program at the end of the year, along with the consequences of the fiscal cliff, will certainly weigh on investor sentiment. The end of prior Quantitative Easing (QE) programs have been met with a weakening equity market.

From The Blog of HORAN Capital Advisors

Source: Schwab

• Ongoing, Euro Zone Issues: The one issue that will not end any time soon is that of the EU. This European Debt Crisis link not only outlines the current actions taken by the European Union, but also is evidence of the many steps yet to be taken in an attempt to resolve the crisis in the EU. It is almost certain that every news headline on EU efforts to deal with their debt crisis will be market moving. Some will move the market higher and some will result in the equity market moving lower. The point is the EU issues will inject volatility into global markets.

Very near term, companies will begin reporting second quarter earnings. The bar is set pretty low for earnings with earnings estimated to increase only 3% in Q2. Since the beginning of Q2, earnings growth expectations have been reduced from 6.8%. According to Factset Research, analysts have reduced estimates for the third and fourth quarters as well. As of July 6th, the projected growth rate for Q3 2012 has fallen from 6.0% to 2.0%, while the projected growth rate for Q4 2012 has fallen from 16.1% to 13.9%.

The above are just some of the macro issues that will face investors in the balance of the year. The Conference Boards Consumer Confidence Index reported at the end of June showed a fourth straight monthly decline in confidence. The Board notes if this trend continues it is most likely to begin to negatively impact consumer spending.Maybe consumers and investors are taking note of these potential issues already.

Economic Decoupling Intrigue

With the hurdles facing many of the countries in the Euro zone, strategist have been tossing around the idea that the U.S. economy may in fact be decoupling from the rest of the economies around the globe. This is certainly an intriguing thought and would be supportive of better equity returns in the U.S. Better equity return doesn't necessarily mean positive returns though.

One recently cited data point is the strength of the U.S. PMI (Purchasing Managers Index) relative to other country PMIs. The PMI measures the health of the manufacturing sector of the economy. Readings greater than 50 indicate the manufacturing sector is expanding while readings under 50 indicate a contracting manufacturing sector. As displayed in the below chart, the U.S. has been a standout versus a number of the other countries and regions.

From The Blog of HORAN Capital Advisors

Source: Charles Schwab

The above chart is showing data through May and the recently reported June U.S. PMI came in at 49.7. This was the first below 50 reading for the U.S. PMI since July 2009. With the June report, it appears decoupling may in fact not be occurring since the manufacturing segments of many economies are now contracting. It is not surprising the U.S. PMI is now below 50 given the interconnectedness of the world economies and the large percentage of revenue generated outside the U.S. by U.S. companies.

From an equity market return perspective, the equity returns in the U.S. still appear to be positively correlated with equity returns outside the U.S., as well, specifically, Europe and the emerging markets. In the two charts below there remains a positive correlation between the S&P 500 Index and both the STOXX 600 Index (Europe) and the MSCI Emerging Markets Index. Positive correlation numbers indicate the two indices move in the same direction. For the emerging market index and the S&P, the recent correlation coefficent equals .62. This means 38% (.62 squared) of the variation in return is related.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

In the end, I do not believe we will see a complete decoupling of the U.S. markets and economy with the other markets and economies around the world. I do believe the U.S. is in slightly better shape than many of the Euro zone economies as well as some emerging markets. Therefore, on a relative basis, the U.S. could continue to outperform a number of its foreign counterparts, with one example being the recent performance of the S&P 500 Index relative to the performance of the emerging markets index detailed below.

From The Blog of HORAN Capital Advisors

After the emerging markets outperformance from 2000 through 2010, maybe the S&P is poised for stronger relative returns in the coming decade for a whole host of reasons. Market returns do not move higher in a straight line and market volatility is likely a continuing theme. Additionally, there are near term potential headwinds: an upcoming debt ceiling debate, the fiscal cliff, the U.S elections in November, just to name a few. For a more detailed review of factors to consider, Charles Schwab's Chief Investment Strategist, Liz Ann Sonders' recently released the July Market Snapshot video and it is a worthwhile video to view.

Dividend Payments and Buybacks Decline In First Quarter

Both aggregate dividend payments and buybacks for companies in the S&P 500 Index declined in the first quarter of 2012. The decline in dividend payments is not unusual as first quarter payment amounts have been lower in Q1 versus the prior Q4 in ten out of the eleven first quarter periods since 2001. The pattern for buybacks is more mixed as aggregate buybacks have declined in six of the eleven first quarter reports since 2001. On a year over year basis, dividends are up 14.2% while buybacks actually declined 6.2%. S&P notes this decline in YOY buybacks is the first decline since the fourth quarter of 2009.

From The Blog of HORAN Capital Advisors

In a report from S&P on Tuesday, they note net dividend payments in the second quarter where higher by $12 billion, which S&P believes is a record dividend payout in aggregate dollars terms for U.S. domestic equities. Howard Silverblatt, Senior Index Analyst at S&P notes,

"Payout rates, which historically average 52%, remained near their lows at 31%. At this point, we expect to see double-digit growth in actual dividend payments for the remainder of 2012, which would equate to a 16% gain over 2011."

Complicating dividend payment trends beyond this year is the impact expiring tax legislation will have on dividends at the end of 2012 that could increase the tax rate on dividends to over 43% versus the current 15% rate.

Will Individual Investors Continue To Get The Market Direction Right?

One thing investors experienced and seemed to have learned was their mistake of piling into the stock market at the top of the technology bubble in 2000. As the below graph indicates, investors allocated significant dollars to equities, based on monthly mutual fund flows, just prior to the technology bubble bursting in early 2000. However, since that time, investors seem to be timing their market moves correctly. At the bottom of the tech bubble in 2002, investors began investing funds into equity mutual funds fairly steadily up until 2008. At the top of the market in 2008, just prior to the financial crisis that impacted the market in 2008-2009, investors began pulling funds from equities and subsequently reinvesting in stocks at the end of the recession.

From The Blog of HORAN Capital Advisors

However, since mid-2010 the S&P 500 Index is up nearly 35% and investor flows into equity mutual funds have actually been negative. They seem to sense a better opportunity in bonds. Not that bonds haven't delivered reasonable returns, but bond returns have trailed returns for the broader equity market over the most recent 2-year time period.

From The Blog of HORAN Capital Advisors

As the above two charts indicate, investors have not warmed up to equities over the last two years. There are many reasons why, volatility, euro zone issues, issues in Washington, DC, etc., but, will they be proven correct this time? The equity markets do seem to be climbing that proverbial wall of worry and maybe pessimism about the markets is overdone to the downside vis-à-vis fundamentals.

The Consequences of U.S. Government Expenditures Outpacing Revenue

One fact of little debate is the U.S. continues to spend at a rate far outpacing the amount of revenue it receives. The consequence of this level of spending is the U.S. government continues to take on a greater amount of debt each year. Further complicating this mismatch between revenue and expenditures is the level of "mandatory" expenditures is growing at a 7% rate according to the OMB. A recent report by Charles Schwab and Argus Research notes:

• Government outlays soared from 20.1% of GDP in the last Bush term to 24.4% in 2009-12. Meanwhile, government receipts fell from 17.9% of GDP in the last Bush years to 15.3% in the Obama years.

• Over half the drop in receipts has been due to lower payroll taxes.

• After 2013, the Office of Management and Budget projects interest on publicly held debt will jump
  from 8.8% to 14.5% of total receipts.

• OMB also projects that “mandatory” federal spending will rise at a 7% annual rate, from 2011 to 2017— as fast as it did in the past six years.

• The deficit is expected to decline to 3% of GDP over time, but that is based on the assumption that individual and corporate income taxes rise by rates of 10% and 17%, respectively.

From The Blog of HORAN Capital Advisors

Investor Equity Fatigue

It is understandable that investors have developed fatigue when it comes to investing in stocks. As the below chart shows, since 2000, investors have essentially made no money in stocks. Compounding this is the fact that the return necessary to recover from the equity market declines is more than double the losses that have been incurred.

From The Blog of HORAN Capital Advisors

One outcome of the equity market volatility is investors have continued to allocate more of their investment dollars to fixed income/bond investments. Given the low level of interest rates though, a spike higher in rates can have a detrimental impact on ones bond portfolio. Many investors experienced this outcome in the first quarter this year.

From The Blog of HORAN Capital Advisors

At HORAN, we believe investors can still make money in stocks; however, a buy and hold strategy will not provide the best return outcome in this environment. Being more tactical and taking a little money off the table (taking some gains) when stocks run up is a necessity during these times.

Where To Invest In The Coming Years

Richard Bernstein of Richard Bernstein Advisors and Bill Wilby, former manager of the Oppenheimer Global Fund discuss why the U.S. is the best place to invest in the coming years. For equity investments Bernstein's favorite asset class is small capitalization companies while Wilby is focusing on high quality large capitalization dividend payers.

Source: WealthTrack

The New Normal: Continued Volatility

A recent investment newsletter from PIMCO's Neel Kashkari, takes a look back at PIMCO's application of the "New Normal" comment for the global economy in the spring of 2009. "The New Normal called for long-term deleveraging that would lead to lower growth than society had been accustomed to." One outcome of this New Normal cycle has been an increase in market volatility.

A result of this heightened volatility is the fact investors have become skeptical of the equity markets. PIMCO notes:

• "From May 2002 to May 2007, during the old normal, the S&P 500 experienced a 5% correction from a recent high five times, or on average of once per year, and a 10% correction four times."

• "In the three New Normal years from May 2009 to May 2012, the S&P 500 experienced seven 5% corrections, more than twice as often, and a 10% correction three times."

This increased downside volatility is evidence investors should consider investment strategies that could limit the negative impact of downside market returns. Aside from sitting in cash, some of the strategies mentioned in the article include:

• "Buying higher-quality companies and those with strong balance sheets, because they tend to be more resilient against shocks, according to our research."

• "Buying companies at deep discounts to their intrinsic value."

• "Buying companies offering more immediate return on investment through dividends."

• "Actively hedging the portfolio, with tail risk hedging (which refers to taking a defensive position against extreme market shocks), or other means."

• "Investing in multi-asset solutions that provide diversification and include equities, fixed income securities and commodities in one vehicle."

Lastly, investors and investment advisers have a choice between active and passive investment management. A potentially significant drawback of passive investment in the New Normal environment, i.e., more frequent market declines,  is investor returns will decline with the market. The S&P 500's near 40% decline in 2008 is evidence of this type of market action. For investors taking distributions from their accounts, returns like those incurred in 2008 can be more detrimental.

For investors that incorporate some downside protection in their investment strategy, this does not come without a price. Downside protection is likely to limit some of the returns achieved in an up market. However, outperforming in a down market can still result in outperformance and higher compound returns over a complete market cycle.

Source:

Three Years and Counting
By: Neel Kashkari
PIMCO
June 2012
http://www.pimco.com/EN/Insights/Pages/Three-Years-and-Counting.aspx

Individual Investor Bullish Sentiment Remains Low

In today's sentiment survey released by the American Association of Individual Investors, bullish investor sentiment declined to 28.02% versus last week's reading of 30.47%. The bull/bear spread was also more negative at -14% versus -8% in the prior week. Additionally, the 8-period moving average of bullish sentiment is at its lowest level, 28.7%, since March of 2009 when this average was reported at 27.5%.

From The Blog of HORAN Capital Advisors

The AAII sentiment survey is a contrarian indicator and this low bullishness level is only one indicator that might suggest the market is at a low point; however, Barry Ritholtz of The Big Picture website points to an analysis by Jim Bianco at Bianco Research noting the confused sentiment of the market based on newsletter writers. Certainly, a number of issues like the euro zone crisis seem to be driving sentiment at the moment, along with recently reported weaker economic data in the U.S.

Jason Trennert: The Bill Has Come Due

Jason Trennert is interviewed by Consuelo Mack on this week's WealthTrack. Jason discusses where investors should consider allocating their investments given the uncertainty surrounding the upcoming elections and the so called $537 billion "fiscal cliff" looming large at the end of the year.

The fiscal cliff is in reference to the expiration of the so-called Bush tax cuts, expiration of the payroll tax cut, the implementation of automatic spending cuts and the initiation of additional taxes to support the new healthcare law all beginning in 2013. This fiscal cliff is 3.5% of GDP and would likely have a negative impact on economic growth in the U.S. Additionally, Jason believes high quality dividend paying stocks are like "new sovereigns" given the low level of interest rates on U.S. government debt.

Equity Put/Call Ratio Approaching 1.0

In the third week of August last year we noted the equity put/call ratio had climbed above 1.0 as noted in the post, Equity Put/Call Above 1.0 Again. As we wrote in that post,

"The equity P/C ratio tends to measure the sentiment of the individual investor by dividing put volume by call volume. At the extremes, this particular measure is a contrarian one; hence, P/C ratios above 1.0 signal overly bearish sentiment from the individual investor. This indicator's average over the last 5-years is approximately .7, indicating the individual investor has been generally mostly bullish and more active on the call volume side"

The S&P 500 Index closed at 1,123 on 8/19/2011 and traded sideways to down before reaching a low of 1,099 on 10/3. So from August 19 to October 3 of last year, the S&P fell an additional 2.1% after the equity put/call ratio rose above 1.0.

Well, here we are today with the P/C ratio approaching 1.0 again and bearish sentiment at elevated levels.

From The Blog of HORAN Capital Advisors

The news that triggered the decline last year is not too different from the news impacting the market currently. Following is what we wrote in August last year.

"At HORAN, we believe business fundamentals are contrasting with equity market actions. This divergence is being driven in large part by the lack of confidence in Europe in dealing with its sovereign debt issues and in Washington's inability to deal with its budget deficit. Additionally, the amount of regulatory uncertainty that includes health care reform and potential income tax reform is a factor in business' ability to commit to longer term expansion plans."

Liz Ann Sonders, Chief Investment Strategist at Charles Schwab, notes,

But there is a long list of positive offsets this year relative to the past two years:

• Inflation is coming down, especially among commodity prices.
• Credit growth is quite strong, especially for consumers.
• Housing has improved markedly.
• The US manufacturing sector is humming.
• NFIB's small business survey made recent upside breakout.
• Job growth is much better.
• Consumer confidence is improving.
• Private-sector leverage ratios are much improved (debt servicing costs are extremely low).
• Recovery in state/local government spending.
• The US economy somewhat decoupling from rest of world; at least Europe.
• US bank capital/health is much better than Europe's.
• The European Central Bank's Long-Term Refinancing Operations have reduced likelihood of global financial contagion.
• Germany appears more willing to accept higher inflation, opening the door to easier monetary policy for the eurozone.
• Valuations are quite cheap, especially on forward earnings.
• Investor sentiment has improved sharply with the correction to-date (meaning pessimism has kicked back in).

It is difficult to predict a market bottom and certainly the S&P 500 index could trade lower in the very near term; however, business fundamentals look positive and sentiment is approaching levels indicating pessimism may be overdone. 

Significant Drop In Investor Bullish Sentiment

The American Association of Individual Investors reported a significant drop in bullish investor sentiment this morning. The bullish sentiment fell ten percentage points to 25.40% versus 35.40% last week. This week's reading is the lowest level for bullish sentiment since September 22nd last year when bullish sentiment was reported at 25.33%. The bull/bear spread is now -16.66% versus last week's spread of 6.93%.

From The Blog of HORAN Capital Advisors

Earned Success Or Learned Helplessness: Choosing A College Degree

This post is a little bit off the path of a direct investment market or economic topic that I generally write. However, the observations do have implications for the employment market and how future college graduates might improve their employment prospects.

We are entering that time of year where students are celebrating their graduation from high school and college. Having recently attended Indiana University's graduation and talking with some of the graduates, it was evident that not all seniors were successful in securing a job. Prior to the IU graduation, I attended the academic signing day at the high school in our community. The academic signing is where the top graduating seniors, i.e., those achieving a 4.0 or higher grade point average during their 4-years of high school, announce their college choice and intended major. The common thread for both functions I attended is the selection of ones major is an important decision and can significantly impact one's marketability upon graduating from college.

For the high school seniors going on to college, the end of their college days are a long way off, at least 4-years, and a lot can change economically that affects the job market. However, I was surprised at some of the intended majors announced by some of these top high school seniors. Several of the majors announced by the graduating seniors fell into an area of study that currently has one of the highest rates of unemployment.

Several recent articles in the Wall Street Journal touch on some of the issues facing college graduates. It may seem obvious, but one important factor is the major pursued by college graduates. In many emerging economies, students in those markets select majors in either a hard science or engineering. Degrees in these fields provide one with an education that qualifies them for a number of job disciplines, even jobs that are not directly tied to the area of study. The WSJ article, "To the Class of 2012," notes a number of today's graduates lack factual knowledge due to the education community's focus on teaching "thinking" skills at the expense of having students learn facts. As noted in the article,

"Many of you [college graduates] have been reared on the cliché that the purpose of education isn't to stuff your head with facts but to teach you how to think. Wrong. I routinely interview college students, mostly from top schools, and I notice that their brains are like old maps, with lots of blank spaces for the uncharted terrain. It's not that they lack for motivation or IQ. It's that they can't connect the dots when they don't know where the dots are in the first place."

The article went on to note,

"In every generation there's a strong tendency for everyone to think like everyone else. But your generation has an especially bad case, because your mass conformism is masked by the appearance of mass nonconformism. It's a point I learned from my West Point intern, when I asked her what it was like to lead such a uniformed existence.

Her answer stayed with me: Wearing a uniform, she said, helped her figure out what it was that really distinguished her as an individual."

The other Wall Street Journal article, America and the Value of 'Earned Success', highlighted the author's path after he left Spain a number of years ago. In Spain this was unheard of since many job functions were guaranteed for life. If the job did not pan out, they found ways to qualify for lifetime disability paying the same salary as their job. When the author and his wife arrived in the U.S., they both ultimately landed jobs. The individual notes, "In the end, I concluded, what set the United States apart from Spain was the difference between earned success and learned helplessness (emphasis added)." The author goes on to note,

"The link between earned success and life satisfaction is well established by researchers. The University of Chicago's General Social Survey, for example, reveals that people who say they feel "very successful" or 'completely successful' in their work lives are twice as likely to say they are very happy than people who feel 'somewhat successful.' It doesn't matter if they earn more or less income; the differences persist.

The opposite of earned success is 'learned helplessness,' a term coined by Martin Seligman, the eminent psychologist at the University of Pennsylvania. It refers to what happens if rewards and punishments are not tied to merit: People simply give up and stop trying to succeed.

Learned helplessness was what my wife and I observed then, and still do today, in social-democratic Spain. The recession, rigid labor markets, and excessive welfare spending have pushed unemployment to 24.4%, with youth joblessness over 50%. Nearly half of adults under 35 live with their parents. Unable to earn their success, Spaniards fight to keep unearned government benefits.

Meanwhile, their collective happiness—already relatively low—has withered. According to the nonprofit World Values Survey, 20% of Spaniards said they were "very happy" about their lives in 1981. This fell to 14% by 2007, even before the economic downturn.

That trajectory should be a cautionary tale to Americans who are watching the U.S. government careen toward a system that is every bit as socially democratic as Spain's.

Government spending as a percentage of GDP in America is about 36%—roughly the same as in Spain. The Congressional Budget Office tells us it will reach 50% by 2038. The Tax Foundation reports that almost 70% of Americans take more out of the tax system than they pay into it. Meanwhile, politicians foment social division on the basis of income inequality, instead of attempting to improve mobility and opportunity through education reform, pro-growth policies, and an entrepreneur-friendly economy.

These trends do not mean we are doomed to repeat Spain's unhappy fate. But our system of earned success will not defend itself." 

For the graduating high school seniors and college seniors continuing their education, certainly pursue a field of study that you are passionate about, while at the same time making the education pursuit a rigorous one. Don't simply focus on classes that inflate your GPA if the course truly does not increase your factual knowledge. A rigorous course of study could mean the difference between "earned success" and "learned helplessness."

Dividend Payers Outperform In April

Standard & Poor's April performance update for the dividend payers versus non-payers in the S&P 500 Index shows the payers outperformed in April. The outperformance was almost 200 basis points or two percentage points, 1.72% versus -.12%, respectively. In spite of the strong April performance for the payers, the payers trail the non-payers on a year to date basis, 13.35% versus 16.40%, respectively. For the twelve month period, the payers have outperformed by more than 700 basis points though.

From The Blog of HORAN Capital Advisors

Data source: S&P

Why Economic Growth Has Been So Low

As many of our clients and prospective clients know, we frequently discuss the strength of the corporate sector of the economy. As the below chart shows, corporate profit growth has continued to strengthen.

From The Blog of HORAN Capital Advisors

With this level of corporate profit strength, one has to ask why economic growth (GDP) has not been stronger. The first report on first quarter GDP Friday indicated growth was running at 2.2% versus expectations of 2.5%. A recent post at the blog, Calafia Beach Pundit and written by Scott Grannis, the former Chief Economist at Western Asset Management, notes the drag the government sector is having on economic growth:

"Here's another way of appreciating what has happened in recent years. The private sector has been working very hard to increase its efficiency and its output, and that shows up in the record level of corporate profits, both in nominal terms and relative to GDP. But instead of allowing or encouraging the private sector to plow those profits back into the economy in the form of new plant and equipment, new jobs, and new technologies, the federal government has effectively borrowed all the corporate profits generated since 2009 and distributed the money to the unemployed, to the poor, to favored "green" industries, to unions, to state and local governments, and to "make-work projects," among other things. There's been a lot of money thrown around, but lots of it has been wasted in the process that could have been put to better use; we simply don't have much to show for the $1.25 trillion of after-tax profits generated per year on average by U.S. businesses since 2009. (I'm referring here to the fact that federal deficits in recent years have been roughly equivalent to after-tax corporate profits—actually a bit higher. So on a "sources and uses of funds" basis, the government has effectively used all corporate profits to fund its spending.)"

GDP is commonly defined as:

GDP = C + I + G + (X - M)
Where,

• C = private consumption
• I = gross investment
• G = government spending
• (X - M) = exports - imports

Government expenditures on final goods and services includes salaries of public employees, purchases of military equipment and any investment expenditure by the government. It does not include transfer payments, such as social security or unemployment benefits.

As Scott Grannis notes in his article, there are many aspects of government expenditures that have not been additive to U.S. economic growth in spite of the strength in the corporate sector of the economy.