Investor Letter Fall 2014: Sailing Into The Wind

HORAN Capital Advisors recently published its Fall 2014 Investor Letter. The consensus view at the start of 2014 was interest rates would rise and economic growth would be globally synchronized led by the U.S. Now three quarters of the way through 2014, it appears economic growth in the U.S. is the only consensus viewpoint being realized.

Although we are just a month past the end of the third quarter, September 30th seems a distant memory. The third quarter ended on a weak note for most asset classes. In the Investor Letter we note headwinds that impacted the equity markets and resulted in equity market performance in the third quarter being the weakest since the third quarter of 2011. The beginning of the fourth quarter has continued to be volatile even with corporate earnings releases progressing better than expected.

The 10‐year treasury rate at the beginning of 2014 was 3.03%. The 10‐year treasury ended the third quarter at 2.3% and just recently hit a low of 1.87% on October 15th. The October 15th rate plunge occurred on a day when the Dow Jones Industrial Average swung 458 points, nearly 3% from high to low. For perspective on our views for the balance of the year and into 2015 one can read our Investor Letter accessible at the below link.

• Fall 2014 Investor Letter

From The Blog of HORAN Capital Advisors

Nikkei Rally, But Pay Attention To Currency Exchange Rates

Today Japan announced an surprising boost to its quantitative easing program. The result was a significant jump in Japan's Nikkei 225 index closing up 4.83%. For some or many investors there is an awareness to QE programs seem to be positive for equity prices. Knowing this, ones instinct is to increase investment allocations to economies and markets where QE is being pursued. However, investor's must keep in mind the impact exchange rates will have on non-U.S. market returns when converting the non-dollar returns back to the U.S. Dollar. The recent Dollar strength, and likely a strengthening trend longer term, results in the Nikkei return in Dollars significantly trailing the S&P 500 returns. As the below chart shows, with the strong Nikkei performance today, the Nikkei return is now ahead of the S&P 500 Index (likely not the case after U.S. market open.) The blue line on the below chart shows the Nikkei return in Dollars.

From The Blog of HORAN Capital Advisors

Week Ahead Magazine: How Quickly Sentiment Changes

At the start of this past week it seemed the bears were out in force and it led to selling pressure on the indices through Wednesday. However, trading on Wednesday may have been a capitulation day as the S&P 500 Index and Dow Jones Industrial average were down nearly 3% from their respective day's high and low. The market turnaround carried through to the week's end. The only index managing to gain on the week though was the small cap Russell 2000 index which was up 2.8%. Small caps have struggled since late last year and remain down 7.0% year to date.

A number of articles in this week's magazine focus on the change in investor sentiment from bearish to more bullish. Ben Carlson, CFA, who writes for A Wealth of Common Sense, referenced a financial advice quote from Jason Zweig of The Wall Street Journal that sums up what investors should be thinking in these volatile times.

"I was once asked, at a journalism conference, how I defined my job. I said: My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself."

"That’s because good advice rarely changes, while markets change constantly. The temptation to pander is almost irresistible. And while people need good advice, what they want is advice that sounds good."

Below is the link to this week's magazine.

• The Week Ahead Magazine: How Quickly Sentiment Changes

Equity Put/Call Ratio And VIX Indicating Oversold Conditions

Although an equity put/call ratio over 1.0 is ideal for this sentiment indicator to indicate oversold market conditions, the current .91 level is an extreme one. Coupled with the spike in the VIX, today's market bounce is not a surprise.

From The Blog of HORAN Capital Advisors

Further indications of an oversold market are the percentage of S&P 500 stocks trading above their 50 and 200 day moving averages. As the two charts note below, this technical indicator certainly indicates oversold market levels.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Fundamentals drive stock prices in the long run and we believe U.S. fundamentals remain intact and support higher equity prices into year end and at least through the first quarter of 2015. As was noted in the Trahan interview, the U.S. economy seems to be decoupling for international markets and economies. The market does not move higher in a straight line so continued volatility should be expects. As was noted by Bespoke yesterday, the average S&P 500 stock has corrected 13%. With the market down about 6% from its high, some stocks have certainly corrected by a much larger 13%; hence potential opportunity for investors.

François Trahan: Best Four Years Ahead For U.S. Equity Investors

One factor that is a certainty at the moment is there is not a lack of strategy commentary around the future direction of the equity markets. The difficulty for investors is deriving an investment thesis from them since many different conclusions are drawn from the market's recent weakness.

In a recent interview of François Trahan of Cornerstone Macro by Consuelo Mack on WealthTrack, Trahan believes the next four years could be some of the best for U.S. equities. Trahan is a Founding Partner of Cornerstone and was ranked the #1 portfolio strategist by Institutional Investor in 2013. He has received this honor in seven out of the past 9 years.

One key underpinning of Trahan's point of view is the fact macro economic data is responsible for 80% of market moves. In that regard, he believes the U.S. economy and market is decoupling from many of the economies outside of the U.S. If one believes this viewpoint, he notes U.S. economic growth consists of 70% driven by the consumer and only 14% by exports, consumer oriented stocks should do well. As a result U.S. centric investments are an area of the market he expects to do well over the next four years. He does expect further choppiness in the market during the next three months.

One mantra that is getting repeated today is "don't fight the Fed." As the end of QE is near and the Fed poised to increase interest rates, probably mid year in 2015, higher rates are thought to be a negative for equities. He notes, however, that stocks can do well in a rising rate environment. In the 1990's the Fed had four tightening cycles and stocks rose in three of them and were flat in the other. We have commented on this fact as well, Rising Interest Rates Can Be Good For Stocks.

The entire interview below is worthwhile to review.

Week Ahead Magazine: Equity Market Entering Seasonally Strong Period

Last week included two trading days to end the third quarter and three trading days to start the fourth quarter of 2014. In total the week was one where nearly all U.S. and international indices ended in the red. From a positive perspective strength was seen in U.S. markets after mid day on Thursday and this carried over into Friday. For the week though, the Russell 2000 index continues to struggle to find support and was down 1.3% and is now down 5.1% year to date. The other major U.S. indices were down .6 to .8% on the week. Overseas saw braod weakness as well:

• the DAX (Germany) down 3.1%,
• the CAC (France) down 2.6,
• the Nikkei 225 (Japan) down 3.2%, and
• the Kospi (South Korea) down 2.7%.

In spite of the weakness ending the third quarter and at the beginning of the fourth quarter, the market is entering a seasonally strong period.  A number of reports, one included in this week's magazine, note in a midterm election year October is the strongest month on average for the S&P 500 Index. This October market strength carries over into the full fourth quarter through the second quarter of year three of the presidential cycle. History is not a guaranty of future outcomes; however, the future does have a tendency to rhyme.

From The Blog of HORAN Capital Advisors

Source: Dana Lyons

For the week ahead, the economic reporting will be light. Below is a list of the economic data to be reported in the coming week.

From The Blog of HORAN Capital Advisors

Source: Thomson Reuters

Following is the link to this week's Week Ahead Magazine.

• Week Ahead Magazine: October 5, 2014

Nancy Lazar Interview: The U.S. Continues To Be A Driver Of Global Growth

In September of last years we provided some commentary and a link to an interview conducted by Consuelo Mack with Nancy Lazar on WealthTrack, Is Middle America The New Emerging Market? At that time Nancy Lazar stated the Middle America was the new emerging market. In an interview on WealthTrack last week with Nancy Lazar, she continues to highlight the strengths of the U.S. Nancy was a founding partner of ISI Group and recently started her own firm, Cornerstone Macro. She has been rated as a top economist by Institutional Investor magazine for the past decade.

Nancy Lazar notes that China, once thought of as the main growth driver for global growth, is now waning due to China unwinding past excesses. Nancy believes the U.S. has resumed the role of the leading growth driver for economic growth. She notes the U.S. is now growing faster than China in Dollar terms.

From The Blog of HORAN Capital Advisors

A few other highlights from the interview which is worthwhile viewing in its entirety:

• European growth is slowing and this will be a headwind for multinational U.S. companies since 20% of revenue is from Europe. The slowing in Europe is coupled with a stronger U.S. Dollar.
• Lazar likes the U.S. consumer, i.e., discretionary sector, as the consumer has repaired their balance sheet and has become smarter in their spending habits. This is a bit of a double edged sword as consumers will be more discriminating on where they spend; however, she is projecting a strong holiday retail environment.
• Chemical industry benefiting in the U.S. as the U.S. is the low cost producer for natural gas. Seven chemical plants under construction in the U.S. today and the build out of these plants runs through 2017.
• As manufacturing in the U.S. expands, this is creating a multiplier effect in terms of jobs growth. For every one manufacturing job created, 3-4 non-manufacturing jobs are created as well.

In short, Lazar is positive on the U.S. and positive on the Dollar. She believes the U.S. economy is no longer in a crisis position and can stand on its won as the Fed steps away from its support.

Investor Sentiment More Bearish

This past week's investor sentiment report by the American Association of Individual Investors (AAII) indicated investor bullish sentiment continues to decline. The bullish sentiment reading declined 6.42 percentage points to 35.42%. Individual investor sentiment is a contrarian indicator and is most predictive of future price action when the bullish sentiment is at extremes. If individual investors indicate a low level of bullishness, this would be one indication the equity market could be approaching a bottom. Although the current reading is not at an extreme, investors appeared to become less bullish as the market pulled back from its recent high reached in mid-September.

From The Blog of HORAN Capital Advisors

Data source: AAII

Additionally, as the below Google Trends graph shows, the search on the phrase "stock market correction" has increased significantly from September into October. Given the market's turnaround Thursday and continued into Friday, maybe this recent 4.6% correction will be the extend of the pullback as we have seen from the market over the past three years.

From The Blog of HORAN Capital Advisors

September Returns: Practically No Place To Hide

If there is one positive to the close of the month of September it is the fact investors can turn the page and set their sights on October and the fourth quarter. September has historically been the worst performing month in a calendar year and this is even truer when the prior month of August achieves returns greater than 3%. In fact, August of this year saw the S&P 500 Index return 3.8% and the Dow Jones Industrial Average return 3.2%. At the start of September, Ryan Detrick wrote an article, Welcome To September, The Worst Month Of Them All, where he looked at September return expectations under different time frames. Well, September 2014 did not go against the historical data.

As the below two charts show, developed and emerging market equity returns and fixed income returns were mostly negative for the month. The one index that generated positive returns for the month was the livestock index which was up 6.20%. Anyone buying beef/pork type products in the grocery store is well aware of higher beef and pork prices. With respect to equity returns, the safest segment was the large cap sector. Both the Dow and S&P 500 Index were down .23% and 1.40%, respectively in the month of September. The large cap returns were far better than the 4+% to 5+% losses in mid and small cap stocks. Even fixed income or bond returns struggled. Although not displayed below, the one fixed income segment that generated a barely positive return was S&P's National AMT-Free Muni Bond Index which was up .03% for the month of September.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

From a sector perspective, energy, consumer discretionary, utilities and materials were poor performing market segments. The traditionally safe consumer staples were the best performing sector with a monthly return of .63%. This return was not even close to overcoming the -7.55% generated in the energy sector.

From The Blog of HORAN Capital Advisors

In spite of the tough returns for the month of September and the third quarter, the year to date returns in the larger cap stocks remain healthy. As our clients know, at HORAN Capital Advisors, we have been overweight large cap stocks for three or so years. No one knows whether this recent market weakness will lead to the much awaited 10+% correction; however, the market technicals are not terrible as we noted with the chart in our post on Sunday. Certainly, market technical support needs to be found around S&P 1,950-1,960. These price levels represent the 100 day moving average and the 50% fibonacci retracement.

Also noteworthy is the near oversold levels for the percentage of NYSE Composite Index stocks trading above their 50 and 150 day moving averages. As the two charts below note, only 25% of NYSE stocks are trading above their 50 day moving average and 39% trading above their 150 day moving average. Certainly, lower percentages have been reached in the past before the market finds a bottom.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Lastly, historically the 4th quarter has been a positive returning one especially starting late in the second year of the presidential cycle. In an interesting article, The Set Up For A 4th Quarter Rally Is Missing Something, many factors are in place for a 4th quarter rally. One potentially missing ingredient though is the level of investor sentiment, i.e., we are missing the high bearish sentiment reading that has been a variable that has been present in past market bottoms. The just mentioned article is a worthwhile read.

From The Blog of HORAN Capital Advisors

Source: The Fat Pitch

My sense is we may not be at the absolute bottom for this pullback. Potential issues facing investors are a stronger U.S. Dollar, the end of QE in October and the midterm elections in November. For the most part though, economic and company earnings reports are more positive than negative. However, many stocks are down much more than their respective indexes and they are providing an opportunity for investors to begin building positions in some of these stocks.

Dow Dogs Outperforming Dow And S&P 500 Indices

As investor may realize, the Dow Jones Industrial Average has significantly underperformed the broader S&P 500 Index on a year to date basis. The S&P 500 Index is up 7.00% on a price only basis while the Dow Jones Index is higher by only 2.98%. Because the Dow index is a price weighted index, companies in the index with higher stock prices have a larger impact on the Dow index performance. Consequently, higher priced stocks in the Dow have trailed the broader market. For example,

• Boeing (BA), with a price of $128.77, is down 5.7%,
• United Technologies (UTX), with a price of $105.08 is down 7.7% and,
• International Business Machines (IBM), with a price of $187.57 is up only 1.1%.

Interestingly, the Dogs of the Dow for 2014 have outperformed both the Dow index as well as the S&P 500 Index on a year to date basis. As the below table shows, the price only return for the Dogs of the Dow have returned 7.4% through Monday's close versus 7.0% for the S&P 500 Index and 3.0% for the Dow Jones Industrial Average.

From The Blog of HORAN Capital Advisors

Source: Dogs of the Dow

The Dow Dog strategy consists of selecting the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Index (DJIA) after the close of business on the last trading day of the prior year. Once the ten stocks are determined, an investor would invest an equal dollar amount in each of the ten stocks and hold them for the entire year. Investors should note the strategy has generated mixed results over the years though.

Disclosure: family long UTX

Week Ahead Magazine: Fear Headlines - September 28, 2014

After reading some of the market headlines last week, one would have thought the market experienced some type of terrible correction. A couple of headlines from CNBC that are shown below mention the market "springs back after rout" and market "sinks, fear surges." For the week, the S&P 500 Index was down 1.4% while the Dow Jones Industrial Average declined only 1%.

From The Blog of HORAN Capital Advisors

On Thursday, September 18, 2014, the S&P 500 Index hit a closing high of 2,011.36. So, after this past Thursday's market decline, the S&P 500 Index was down 2.26% and ultimately closed the week down only 1.42% from its high. I do not call this a "rout" or a market that "sinks."

Of course, the market seems overdue for a 10+ percent correction, but that does not mean one is around the corner. For the DJIA the last one occurred almost three years ago with the market low in October, 2011. As we noted earlier in the year the market seemed to experience an internal correction when social media and biotech stocks declined sharply in March and April. In the current third quarter it seems a similar situation is occurring as noted by the correction in some market segments. Additionally, a number of energy stocks and industrial stocks have experienced greater than 10% declines in the quarter.

From The Blog of HORAN Capital Advisors

Lastly, in reviewing a couple of technical aspects for the market, the S&P 500 Index, it remains firmly in an uptrend as noted by the green support line in the below chart. Certainly, some technical damage has been inflicted on the market in last week's minor pullback. The market has violated its 50-day moving average and the percent price oscillator (a version of the MACD) is in a negative downtrend as well. From a positive standpoint, the stochastic indicator appears to be turning higher and a positive turn in the PPO would be beneficial. Lastly, the percentage of stocks trading above their 50 day and 150 day moving averages are near oversold levels. The market may find support at the 50% Fibonacci retracement level of S&P 1,960.

From The Blog of HORAN Capital Advisors

Before looking at the week ahead, the economic news last week can be summarized as mixed. Probably the most noteworthy news items had to do with data out of Europe and China. The manufacturing and services sector PMIs for the eurozone dipped to their lowest levels of the year and China existing home sales declined. Potentially offsetting these concerns is the strengthening U.S. Dollar and the resulting impact of making foreign goods cheaper as they are exported to the U.S.

The coming week is loaded with a number of important economic reports.

• Personal income and outlays, pending home sales and Dallas Fed Manufacturing Survey (M)
• Chicago PMI and consumer confidence (T)
• ADP employment report, PMI Mfg index, ISM mfg index and construction spending (W)
• Jobless claims and factory orders (Th)
• Employment situation, international trade report, ISM non-mfg index, global composite PMI and global services PMI (F)

For the week ahead magazine below, a number of links look at recent buyback activity as well as the performance of various market sectors. With a number of individual stocks experiencing significant corrections, one link reviews the fact some stocks just do not mean revert as investors might think. In short, just because a stock looks cheap, it does not mean it will generate market beating returns. And finally, it has been difficult gauging a great deal of insight into investor market behavior based on their sentiment as it has not been overly optimistic nor overly pessimistic. The Gallup article link notes that the "U.S. Investor Optimism Index is at its highest level in Seven Years. This index is officially know as  the Wells Fargo/Gallup Investor and Retirement Optimism Index. I have not reviewed the questions/data closely; however, the index had prior peaks in 2000 and 2007, both market tops. The current index level, though, is far below the 2007 peak.

• Week Ahead Magazine: September 28, 2014

Buybacks Decline 27% In Second Quarter

Earlier this week S&P Dow Jones Indices released their buyback report for the S&P 500 Index. Of note was the 27% decline in buyback value in the second quarter versus the first quarter of 2014. Even on a year over year basis (Q2 2014 versus Q2 2013) buybacks declined 1.6%. Some important highlights from the buyback report:

• "For the 12 months ending June 2014, S&P 500 issues increased their buyback expenditures by 26.6% to $533.0 billion from the $420.9 billion posted during the corresponding twelve month period in 2013."

• "Companies on aggregate...issued fewer shares, with the net change resulting in a lower share count and higher earnings-per-share (EPS)."

• "By reducing their share count, more companies are adding tailwinds to their EPS," says Silverblatt. "During the second quarter, 23% of S&P 500 issuers reduced their year-over-year share count enough to push up their earnings per share significantly versus just shy of 20% during Q1 and 12% during the second quarter of 2013."

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

In the report Howard Silverblatt also comments on the continued need for companies to spend more on buybacks going forward in order to prevent share dilution from employee options that are in the money. These employee options have gained in value as the equity market continues to move higher. This potential increase in buybacks would provide support for a respective company's share price.

The report contains a number of useful tables with dividend and buyback data. Below is the table detailing the top 20 or largest buybacks in the second quarter.

From The Blog of HORAN Capital Advisors

Source:

S&P 500 Q2 Buybacks Decline 27% From Q1 2014
S&P Dow Jones Indices
By: Howard Silverblatt, Senior Index Analyst
September 23, 2014
https://my.spindices.com/documents/index-news-and-announcements/20140923-sp-500-buyback.pdf

Week Ahead Magazine: September 21, 2014

A fairly eventful week last week with the Fed's policy decision essentially leaving rates unchanged and retaining the "considerable time" language in its rate announcement. Alibaba's (BABA) IPO was one for the record books in terms of size. Before investors jump in to buy the stock they should read Aswath Damodaran's commentary on the corporate structure of BABA. With those two items now in the rear-view mirror, the market managed to generate mostly positive returns last week. The one segment of the market having trouble gaining any upward traction is small cap stocks. On the week the Russell 2000 small cap index was down 1.2% and now is down 1.4% on the year. The other broad U.S. indices have generated near double digit returns year to date. The one large cap laggard is the Dow Jones Industrial Average which is up 4.2%.

For the week ahead, a number of economic reports are on the calendar:

• Existing home sales (M)
• New home sales (W)
• Durable goods orders, and jobless claims (Th)
• Second quarter GDP final reading (F)

A number of additional reports will be reported in the coming week, but those noted above are likely to be the most impactful to the markets. This week's magazine contains an assortment of articles readers may find of interest.

• The Week Ahead Magazine: September 21, 2014

The Myth Of High Structural Unemployment

It has been almost a year since taking a look at the Beveridge Curve. In the earlier posts we noted the curve compares the unemployment rate with the job vacancy rate. The job vacancy measure we have used in prior posts is the data from the Job Openings and Labor Turnover Survey or JOLTS report. The limitation of the JOLTS report is data only began to be collected in December 2010. The importance of the Beveridge Curve analysis is the graph provides insight into potential structural unemployment. As the below graph shows, the curve has shifted upward and to the right indicating there may be a structural unemployment issue as job openings are going unfilled.

From The Blog of HORAN Capital Advisors

On the other hand, the Cleveland Federal Reserve Bank recently released a report that looks at the Beveridge Curve shift with data going back to 1951. For pre-JOLTS data, the report incorporated the Conference Board Help-Wanted Online Index (HWOL). As the graph in the Cleveland Fed report shows, the most recent data point has moved inside the curve generated after the 2001 recession.

From The Blog of HORAN Capital Advisors

Source: Cleveland Federal Reserve Bank

A part of the Cleveland Fed's conclusion notes,

"However, one thing is clear: there is no shift to begin with. We believe that this debate and the ensuing evidence showed us that inferences about complicated and ill-defined concepts such as structural change in the labor market cannot be made by just looking for a break in the simple (and reduced-form) empirical relationships between macroeconomic aggregates in the midst of a deep and long recession."

As an aside, one aspect of this recovery that seems to gain a great deal of attention is the continuing decline in the labor force participation rate. The conversation around this data point leads to a discussion that if these non-participants were included in the unemployment data, one, the unemployment rate would be higher and two, the Beveridge Curve would show a more pronounced shift up and to the right. For some, this shift would indicate a structural unemployment issue in this recovery. For a detailed look at participation rate information, Bill McBride of the Calculated Risk blog provides a comprehensive analysis of participation rate data.

From The Blog of HORAN Capital Advisors

Implications Of A Strengthening Dollar And Foreign Sales For S&P 500 Companies

In a recently released report by S&P Dow Jones Indices and authored by Howard Silverblatt, Senior Index Analyst, an analysis is provided for the sales generated outside the U.S. for S&P 500 companies. Although the reporting of foreign sales data is less than complete, S&P's report provides detail on the 239 companies that do provide foreign sales data. The report provides a comprehensive discussion on the companies used in the analysis with a snapshot provided below.

From The Blog of HORAN Capital Advisors

A number of important facts can be gained from reviewing the report; however, one important factor is the impact of a strong U.S. Dollar on reported earnings for U.S. domiciled firms. We touched on the strong dollar issue in a recent post, September And Beyond, and a number of strategists highlighted this issue last week as well. The issue with a strong dollar is the negative impact on earnings when the foreign currency is converted back to the Dollar. The Dollar based company reports fewer dollars because of the Dollar's strength. A good example of this is Aflac (AFL).

In 2013 operating income for the company equaled $6.18 which included a $.76 reduction due to the negative impact of a weaker Yen, i.e., stronger dollar. In the company's second quarter 2014 10-Q, they include a table noting the potential impact of Yen currency moves relative to the Dollar.

From The Blog of HORAN Capital Advisors

Also detailed in the S&P report is the foreign sales percentage by S&P 500 Index sector. Information technology, energy and materials are the three sectors with the largest foreign sales percentage.

From The Blog of HORAN Capital Advisors

Additional detail is provided on specific companies that comprise the sectors and their respective foreign sales allocation.

Importantly, investors will want to evaluate where the foreign sales are generated. Some country currencies may actually trade stronger to the Dollar versus weakening. In total though, the fact the U.S. Federal Reserve is nearing the end of its QE program in October and the simultaneous desire by the European Central Bank to weaken the Euro, a further strengthening of the Dollar is likely. Currency moves are difficult to predict and currency volatility should be expected. For investors, understanding the potential currency impact for companies selling goods outside the U.S. and understanding any currency hedging at the company level, is an important variable at this point in the economic cycle.

Source:

S&P 500 2013: Global Sales Year in Review
S&P Dow Jones Indices
By: Howard Silverblatt, Senior Index Analyst
September 2014
http://us.spindices.com/documents/research/research-sp500-2013-global-sales.pdf?force_download=true

Week Ahead Magazine: September 14, 2014

Although much of the economic news last week came in on the positive side, the major U.S. indices were unable to move to the upside. As we noted in our earlier post today, September And Beyond, investors seem focused on the Fed meeting this week and the Fed's viewpoint on the economy and timing of interest rate increases. In spite of the market pullback last week, the S&P 500 Index is down only 1.1% from the high reached on September 5th.

Potential market moving economic news in the coming week:

• Industrial production (M)
• Producer Price Index (T)
• Consumer Price Index, FOMC Announcement (W)
• Housing starts, jobless claims and Philly Fed Survey (Th)
• Leading Indicators (F)

Given the potential shift on interest rate policy from the Fed, a number of article links in this week's magazine look at the frequency of stocks and bonds declining simultaneously--and it is not a frequent occurrence. Another article link evaluates the markets' performance during mid-term election cycles as well as the pre-election year. Lastly, several articles look at projected economic growth along with corporate actions around dividends and stock buybacks. Below is the link to the coming week's magazine.

• The Week Ahead Magazine: September 14, 2014

September And Beyond

Taking a look at some technical and fundamental data points that have evolved in September, below we provide insight into our thoughts on the market over the next few quarters.

We look at a number of technical indicators, i.e., charting technicals, in an effort to gain some insight into investors' trading sentiment. A number of recent technical indicators have, what we would call, rolled over, which is a negative from a short term market direction point of view. As the below chart indicates, both the PPO and Stochastic indicators are indicating a negative trend for the S&P 500 Index.

From The Blog of HORAN Capital Advisors

However, according to the stock trader's almanac,

"September is still the worst performing month and it is beginning to live up to this reputation once again this year. Average losses since 1950 for September are: DJIA –0.8%, S&P 500 –0.5% and NASDAQ (since 1971) –0.5%."

So, although September tends to be a poor returning month for the market out of all months in a calendar year, the average losses are not significant. Further noted in the Almanac about September,

"Historically speaking September weakness has been a great time to load up on stocks ahead of the “Best Six Months” of the year, November to April and an even better time in midterm years ahead of the best two consecutive quarter span of the four-year-presidential-election cycle."

"The market’s sweet spot of the Four-Year Cycle begins in the fourth quarter of the midterm year (2014). The best two-quarter span runs from the fourth quarter of the midterm year through the first quarter of the pre-election year, averaging 15.3% for the Dow, 16.0% for the S&P 500 and an amazing 23.3% for NASDAQ. Pre-election Q2 is smoking too, the third best quarter of the cycle, creating a three quarter sweet spot from midterm Q4 to pre-election Q2. Applying these average gains to yesterday’s closing prices puts DJIA at 19675, S&P 500 at 2315 and NASDAQ at 5656 at the end of Q1 next year."

One factor we believe influenced the market last week is the coming week's 2-day Fed meeting beginning on Tuesday. The Fed announcement will be at 2:00pm on Wednesday. Some strategist are concerned about the Fed's end of quantitative easing in October, along with the Fed's focus on getting interest rates to a more normal (higher) level. Janet Yellen's indicators du jour are related to employment. On Friday, September 5, the August non farm payroll report of 142,000 was below the consensus estimate of 230,000. One would expect this weak number to indicate the Fed will not hike rates anytime soon. On the other hand, the August payroll number is nearly always revised and the market is anticipating a revision higher; hence, higher rates sooner versus later?

In the short run, at the onset of an increasing interest rate cycle, equities can face some headwind in the initial stages of rate increases. At HORAN, we do not see the Fed increasing interest rates before mid-2015 though. In anticipation of higher rates, the market can cause rates, especially longer term ones, to rise in advance of a Fed rate hike. Some of the equity market's weakness this month is related to this. For example, the 10-year treasury rate has increased from 2.33% at the end of August to 2.61% at Friday's close. Until a clearer perspective is gained on the Fed's rate view, we believe the 10-year trades in a range from 2.30% to 2.75%, maybe as high as 3%.

One factor keeping a lid on higher interest rates in the U.S. is the fact rates in the U.S. are much higher, relatively, than rates outside the U.S. A part of this rate differential is being driven by the ECB's desire to embark on a significant QE program as well. This is resulting in foreign investors allocating investment funds into U.S. bonds and other U.S. investment assets. Also, with the recent increase in U.S. interest rates, this has led to a strengthening U.S. Dollar as evidenced by the trade weighted U.S. Dollar Index below. Since July the Trade Weighted Dollar Index has increased from 76.5 to 78.7 in September.

From The Blog of HORAN Capital Advisors

A strengthening Dollar, versus other currencies, results in foreign investors gaining additional return when they convert the Dollar back into their home currency. A strong Dollar also results in imports being cheaper, the U.S. is a net importer, thus providing for potentially cheaper goods for consumers. A strong Dollar also results in oil prices declining which translates into cheaper gasoline at the pump. Therefore, cheaper import prices and cheaper gasoline can be a positive for U.S. consumers which can lead to improved retail spending. As noted by Econoday, Friday's retail sales number of .6% matched expectations, but July was revised higher at .3%. These retail numbers alone suggests the economy may be stronger than the labor market numbers might suggest. Consumers account for nearly 70% of GDP or economic growth, so this could lead to improved GDP growth in the U.S. During the last week of August, the second reading on second quarter GDP saw an increase to 4.2% versus 4.0% in the first reading at the end of July. Lastly, related to the consumer, we are seeing other commodity prices decline. For example, in agriculture, commodities such as corn have fallen over 27% since May. We believe this will eventually lead to lower beef, pork and chicken prices.

From a broad perspective, outside the U.S., economic data suggests economies are still growing. And although some recent data shows slowing economic activity abroad, the data is not suggesting contraction. On the margin then, foreign economies have stabilized.

With respect to geopolitical concerns and there certainly seems to be many. This type of risk might be reason enough for the market to climb that proverbial "wall-of-worry." The middle east issues do not have the same impact on the U.S. as in the past given the U.S.'s improved domestic energy market, primarily a result of fracking. Putin and his war in Ukraine is certainly one we continue to watch. The middle east and Ukraine issues are known and are likely mostly reflected in current asset prices. Of bigger concern might be the unknown unknown. It is this type of event that is not reflected in current asset prices.

In concluding, the market has had a great run since the end of the financial crisis. We are going on three years without the market incurring a 10%+ market correction. It would not surprise us to see one. Because corrections are difficult to predict or time, we do believe the structure of our client portfolios is such we would be able to fund client lifestyles without upsetting the long term return goals of a portfolio. And, at the end of the day, it is corporate earnings (cash flow) which ultimately drives stock prices in the long run. To that end, we continue to see improved earnings results and outlooks from corporations in their earnings reports. Ned Davis Research (via Charles Schwab) succinctly noted three potential market outcomes in their recent monthly market digest:

WHERE DO WE GO FROM HERE?

Breaking down the five-year run allows us (NDR) to identify the likely next phases. Below are three scenarios and likely leadership trends if each unfolds.

1. Escape Velocity

• Description: Renewed corporate confidence leads to more hiring and capex. The Fed would be able to normalize policy as real GDP approaches 3-3.5%.

• Leadership: Dividend (and to a lesser extent buyback) fixation could be replaced by capex beneficiaries. Mid and late-cycle sectors such as Industrials, Energy, and Technology have capex support. Styles could be less Growth-oriented.

2. Bubble

• Description: If escape velocity is unattainable at this time, the Fed may choose to remain extremely accommodative by not raising short-term rates or even instituting QE4. The combination of the Fed’s forcing investors into riskier assets and lack of earnings growth could push valuations to levels not seen since the late 1990s Tech bubble.

• Leadership: Bubble phase - Growth stocks that can deliver in a slow-growth environment and yield plays.

• Bubble aftermath – defensive sectors not caught in the bubble.

3. Valuation Correction

• Description: If the economy fails to reach escape velocity but the Fed normalizes policy, then stretched valuations suggest the market is vulnerable to a correction. As long as a recession is avoided, any correction should be limited to less than 20%. Continued modest earnings growth would lower multiples.

• Leadership: Large-caps over small-caps.

• Defensive Value sectors, which would benefit from the likely decline in long-term interest rates during a correction.

Risk Versus Volatility

Howard Marks, Chairman of Oaktree Capital Markets released his most recent client letter, Risk Revisted. As Marks notes in his letter, he dedicated three chapters of his book, The Most Important Thing, on the subject of risk. In his client letter, he expands on risk and discusses 24 different forms of risk. A couple of highlights from his client letter:

• There’s little I believe in more than Albert Einstein’s observation: “Not everything that counts can be counted, and not everything that can be counted counts.” I’d rather have an order-of-magnitude approximation of risk from an expert than a precise figure from a highly educated statistician who knows less about the underlying investments. British philosopher and logician Carveth Read put it this way: “It is better to be vaguely right than exactly wrong.”

• No ambiguity is evident when we view the past. Only the things that happened happened. But that definiteness doesn’t mean the process that creates outcomes is clear-cut and dependable. Many things could have happened in each case in the past, and the fact that only one did happen understates the variability that existed. What I mean to say (inspired by Nicolas Nassim Taleb’s Fooled by Randomness) is that the history that took place is only one version of what it could have been. If you accept this, then the relevance of history to the future is much more limited than may appear to be the case.

• Knowing the probabilities doesn’t mean you know what’s going to happen.

• Bruce Newberg says, “There’s a big difference between probability and outcome.” Unlikely things happen–and likely things fail to happen–all the time. Probabilities are likelihoods and very far from certainties.

His letter is a worthwhile reading for investors. The potential risks facing investors searching for yield is elevated in an environment where the Fed has pushed interest rates to near zero. Equally, the search for capital appreciation is equally challenging as equity prices are no longer at levels reached subsequent to the financial crisis.

Week Ahead Magazine: September 7, 2014

Last week's holiday shortened trading saw fractional gains in most major U.S equity indexes except for the small cap Russell 200 Index. The small cap index declined .4% on the week and only remains up .6% for the year. Small caps continue to lag the broader S&P 500 Index which is higher by 8.6% year to date through Friday's close. The one piece of weak economic news reported last week was the +142,000 increase in non-farm payrolls. The consensus estimate prior to the release was an anticipated increase of 230,000. The market seemed to shake off this miss as the month of August tends to be a particular month that is frequently revised.

The coming week will be light on potential market moving economic reports. Jobless claims will be reported Thursday and retail sales will be reported on Friday. Given the importance of the consumer on GDP, the retail report will be watched closely. The magazine link below includes an article by  Liz Ann Sonders of Charles Schwab highlights sentiment data, GDP component changes from Q1 to Q2 and a number of additional pros and cons on recent economic data.

Lastly, the U.S. market has managed to dismiss geopolitical events around the globe. An event that will take place on September 18th is the Scottish referendum to separate from the United Kingdom. A couple of articles in the magazine touch on the potential significance if the referendum is approved by the Scottish citizens.

• The Week Ahead Magazine: September 7, 2014

Individual Investors Not Overly Bullish

This week's sentiment survey from the American Association of Individual Investors notes bullish sentiment declined 7.25 percentage points to 44.67%. Two thirds of the decline went into the bearish category while the other one third went into the neutral category.  A less volatile measure is the 8-period moving average of the bullish sentiment reading and it rose to 38.3% from last week's 37.4%. The 8-period moving average is not indicating either an overly bullish sentiment or an overly bearish sentiment environment.

From The Blog of HORAN Capital Advisors

Data source: AAII

As a point of reference, 2013 saw strong market returns from the S&P 500 Index and sentiment readings at the end of 2012 compared to this latest report are noted below.

From The Blog of HORAN Capital Advisors