The FANG Basket Of Stocks Gets Derailed

Investors not owning the basket of stocks know as the FANGs (Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOGL aka Alphabet)) in 2015 likely trailed the return of the broader market. The average return of the FANGs in 2015 equalled 83% versus the S&P 500 Index return of 1.4%.

With the emotional propensity for investors to buy what feels good, if they purchased the FANG basket of stocks near year end, the return on these stocks has trailed the overall market return: -12.6% versus -6.4% for the S&P 500 Index since December 4, 2015.

The weakest link in this basket has been Netflix which has declined 27.6% since the December peak of the FANG basket. The best performing FANG stock since their December top has been Facebook returning 1.6% and outperforming the S&P 500 Index return of -6.9%. The S&P 500 Index has outperformed the other three FANGs, Alphabet, Amazon and Netflix.

Disclosure: Long GOOGL and GOOG

Are Emerging Markets The Trade Of The Decade?

In recent days, more strategists are indicating the emerging market asset class is providing investors with a 'trade of the decade" opportunity. The most recent is Robert Arnott and Christopher Brightman of Research Affiliates when they note in their February All Asset report,

"Many investors mistake a bear market for diminished prospective returns. From the rear-view mirror, the bear market in emerging markets has been painful. When we look out of the windshield, however, these very asset classes offer the highest potential returns (as of 12/31/2015 their 10-year expected return is 7.9%) available to today’s opportunistic investor. So, the exodus from emerging markets is a wonderful opportunity – and quite possibly the trade of a decade – for the long-term investor."

Certainly, the below chart shows the underperformance of the MSCI Emerging Markets Index versus the S&P 500 Index.

For investors interested in increasing emerging market exposure, they will want to evaluate the potential impact of further US Dollar strength due to the negative impact a strong Dollar has on emerging market performance.

Historically, Dollar strengthening moves have trended in a 7-year cycle. As the below chart shows, the most recent Dollar move has been running for about four and a half years. If the seven year pattern holds, continued weakness in emerging market performance may persist. Admittedly, a lot of the Dollar strengthening move has occurred; however, with the Fed interested in continuing to normalize interest rates, higher U.S. rates would likely provide some tailwind for additional Dollar strength.

Bearish Sentiment And Positive Uptick In Economic Reports May Translate To Higher Equity Prices

Evident from the below chart of the S&P 500 Index and the Dow Jones Industrial Average, the start to 2016 has been a difficult one for investors. January saw a sharp decline in the equity markets; however, the month of February is working to repair the January damage.

We noted in a post at the end of the third weak of January, Sentiment Supportive Of Further Equity Gains, that sentiment data seemed overly bearish and the market could recover. Certainly this has been the case, yet institutional and investor sentiment continues to tilt more bearish than bullish.

The chart below displays the NAAIM Exposure Index. The NAAIM Exposure Index consist of a weekly survey of NAAIM member firms who are active money managers and provide a number which represents their overall equity exposure at the market close on a specific day of the week, currently Wednesday. Responses are tallied and averaged to provide the average long (or short) position or all NAAIM managers, as a group. This week's data for the NAAIM Index continues to indicate active managers remain cautious on the equity market and is near levels notable for oversold markets.

Additionally, although individual investors are slightly more bullish based on the Sentiment Survey from the American Association of Individual Investors, bullish sentiment remains at a low level. Last week's AAII report saw investor bullish sentiment increase to 31.19%, the first reading over thirty since the end of November last year. In order to smooth out the week to week volatility in the sentiment reading, we look at the 8-period moving average. As the white line in the below sentiment chart shows, this average continues to track at an extreme level, even lower than that reached at the bottom of the financial crisis in March of 2009.

One data point needing to see improvement is that associated with the consumer and a reasonably strong spending and income report was delivered for January. It appears the benefit consumers receive through low energy prices are beginning to translate into increased spending.

Econoday's commentary on the report:

"Personal income jumped 0.5 percent in January as did consumer spending, both readings higher than expected. Details are solidly positive with components on the income side led by wages & salaries, up a very strong 0.6 percent for the third large gain of the last four months. And year-on-year rates are climbing again with total income up 4.3 percent and with wages & salaries at 4.5 percent, which are far from torrid but the direction is definitely favorable. And consumers didn't draw from savings on their January shopping spree, with the savings rate unchanged at a very solid 5.2 percent. Components on the spending side are led by durable goods which jumped 1.2 percent and reflect strong vehicle sales in the month. Spending on services rose a monthly 0.6 percent. Year-on-year, spending is up 4.2 percent. Again, this isn't great but it does point to a surprisingly strong start to the first quarter which looks to double or triple the fourth-quarter's annualized growth rate of 1.0 percent."

And finally, the improvement in equity returns in February is occurring in some of the more economically sensitive sectors. The below chart shows materials are up 8.5% this month and industrials are higher by 4.9%. At a minimum the market may be beginning to factor in the easier earnings comparisons firms will face as they lap the headwinds from the strong US Dollar and the contraction in energy prices.

One thing we know about the market is it does not move higher in a straight line. The strong recovery over the last two weeks may see some consolidation of these recent gains. However, some glimmer of hope is beginning to surface in a number of economic reports, a revised higher GDP number, an improvement in industrial production and improvement seen in the durable goods report. Everything is not roses as weakness was seen in Markit's Manufacturing PMI and the ISM Manufacturing Index. Investors continue to deal with mixed economic reports, but a number of the reports are beginning to turn positive. If one believes stock prices follow earnings, improvement in earnings reports would be a welcomed outcome. 

E-Commerce Sales Continue At Double Digit Growth Rate

Yesterday, the U.S. Census Bureau released fourth quarter 2015 e-commerce sales data. The report confirmed the fact individuals are increasingly turning to the internet for their retail purchases. The orange line in the below chart shows as of the end of Q4 2015, e-commerce sales as a percentage of total sales increased to 8.6%. Also notable in the below chart is the blue line representing the YOY change in e-commerce sales: e-commerce sales grew nearly 15% in the fourth quarter last year. The increase in internet retail has come at the expense of brick and mortar retailers as evidenced by the near zero percentage growth rate in overall retail sales less motor vehicles and e-commerce sales (green line).

Increased Market Volatility Resulting In High Quality Stock Outperformance

Commensurate with the increase in the market's volatility that began late last year, high quality stock outperformance has accelerated this year. As volatility increases it is common for investors to seek the safety of higher quality equity holdings. The below chart displays the ratio of S&P's high quality index to the low quality index.The S&P Quality Ranking System measures growth and stability of earnings and recorded dividends within a single rank.

• S&P Low Quality Rankings are designed for exposure to constituents of the S&P 500 identified as low quality stocks, i.e., stocks with Quality Rankings of B and below.

• S&P High Quality Rankings are designed for exposure to constituents of the S&P 500 identified as high quality stocks, i.e., stocks with Quality Rankings of A- and above.

One factor contributing to the underperformance of the low quality index is the large 29% weighting in financials versus 5% in the high quality index. As the last chart below shows, financials have taken it on the chin so far this year.

Ex-Energy Forward Earnings Expectations Look Pretty Good

The list of headwinds facing the equity market seems to be growing longer every day. However, the top concern is the question of whether the economy is headed for a recession or not. In several prior posts, we have noted our view is a recession is not imminent. Certainly slow GDP growth continues to be the constant in this long recovery. Much of the market volatility though seems centered around the energy and material sectors.

At the end of 2014 a barrel of oil was trading for $53.27 and closed today at $27.64. Demand for oil has not been the issue, it has been the continued growth in supply. The low energy prices have resulted in large capital expenditure cuts in the sector and this has spilled over into the industrial sector, especially those firms selling into the energy space either directly or indirectly. The earnings results for energy firms and those firms impacted by the energy contraction have dominated the headlines. In evaluating the fundamental health of companies outside of energy, we believe it is worthwhile noting expected 12-month forward earnings growth, ex energy, is anticipated to be just over 13%. We do believe this is a little optimistic; however, high single digit EPS growth is achievable looking out 12-months.

From The Blog of HORAN Capital Advisors

On an operating earnings basis the energy sector is expected to contribute a negative $7.71 to overall S&P 500 Index reported operating earnings in 2015. In 2016, the energy sector is expected to contribute a positive $7.45 to overall S&P operating earnings. Again, we think the energy earnings contribution is on the high side and is one reason we expect 2016 S&P 500 earnings growth around the high signal digits.

Thomson Reuters excellent weekly earnings report from the end of last week included earnings growth expectations for 2016 broken down by quarter. Evident in the below table is the weakness expected for earnings through Q1 2016. For the last three quarters of 2016, earnings growth improves in each quarter. Some of this improvement will be the result of lessening currency headwinds for multinational firms due to the strong US Dollar. At the end of 2014 the US Dollar/Euro exchange rate was $1.20. Through the end of November of 2015, the Dollar strengthened to $1.05 to the Euro. Subsequent to the end of November, the Dollar has been weakening and traded near $1.13 today. This weaker Dollar will lessen the currency impact for many multinational companies.

From The Blog of HORAN Capital Advisors

Much of the bombardment of negative headlines has weighed on investor sentiment. Today the American Association of Individual Investors reported an 8.31 percentage point drop to 19.2% for the bullish sentiment survey reading. These bullish investors flipped to the bearish side with bearish sentiment increasing 14 percentage points to 48.7%. The net impact is the bull/bear spread is a wide -29.5%, the widest level since October 2008. These sentiment readings are most predictive at their extremes and the AAII Sentiment Survey is a contrarian indicator.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Of course there are other issues impacting the market outside of energy and exchange rates, like always seems to be the case. However, we believe the energy headwinds, and the consequent impact on high yield credit and on bank loans, will have a much smaller impact as compared to the real estate issues in 2008/2009. 

Weak Investor Sentiment Leading To Negative Fund Flows

The weak equity returns experienced by the markets since the beginning of the year have resulted in a low level of bullish investor sentiment. The Dow Jones Industrial Average Index and the S&P 500 Index are down on a year to date basis 7% and 8%, respectively. The Nasdaq Composite Index has fared even worse and is down 12.9% this year. The lack of positive equity momentum and weak bullish sentiment have led to investors reducing exposure to both stocks and bonds as evidenced by recent mutual fund flow data.

From The Blog of HORAN Capital Advisors

The above chart incorporates data through the end of last year. Below is a table from ICI showing weekly outflows have continued into 2016.

From The Blog of HORAN Capital Advisors

Source: ICI

In mid-January bullish investor sentiment, as reported by the American Association of Individual Investors, came in at 17.90%. The last time bullish sentiment was reported at this low of a level was in April 2005. Subsequent to the mid-January sentiment report, individual investor sentiment began to improve until falling two percentage points to 27.55% last week.

From The Blog of HORAN Capital Advisors

Source: AAII

As we noted earlier this month, we do not believe the U.S. economy is headed for a recession. Given all the pessimistic talk of late though, one would think we are in a recession now. Because sentiment is a contrarian indicator, and given the negative fund flow data, maybe the end of this pullback is nearer the end than investors are anticipating.

The Dogs Catch A Bid

The Dogs of the Dow theory suggests investors select 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 year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year. Below is the 2016 Dogs of the Dow.

As the below table shows, year to date through Friday's close, the Dow dogs have outperformed the Dow Jones Industrial Index, -2.5% versus -7.0% . As the below table also shows, the average yield for the 2016 Dogs of the Dow of 3.97% remains higher than the overall DJIA yield of 2.96%. In this market environment where the market is struggling to gain any traction, the income yield on the stocks seems to have enticed investors to purchase, or at least hold these higher yielding stocks.

From The Blog of HORAN Capital Advisors

Source: Dogs of the Dow

One aspect of market returns in 2015 was the narrow nature of stock participation. As we noted in our Winter 2016 Investor Letter, the FANG stocks were up over 60% last year on a cap weighted basis. So far in 2016, the average return of the FANG stocks is -12%. The outperformance of the Dow Dogs at the start of 2016 may be a larger indicator of investor interest in more value oriented equities. As the below chart details, growth style equities have been on a strong outperformance trend versus value since the end of the financial crisis. The brief return to value outperformance has occurred during short stints since 2009, but has been unable to gain traction on a longer term basis. Maybe this early trend in 2016 will be the theme for the remainder of the year. We discussed the growth value difference in our post at the end of last year, 2015 Was A Year For Growth Stocks And Only A Handful Were Needed.

From The Blog of HORAN Capital Advisors

Economic Weakness Centered In Energy/Materials Sector: Not A Recession Yet

A significant issue facing investors is determining whether the world is entering into a global recession. Certainly, economic activity in emerging markets has been challenged due in part to the strength of the U.S. Dollar. Global economies are also dealing with the collapse of energy prices and the negative impact energy weakness is having on the broader industrial sectors as energy capital expenditure cuts ripple through the economy. As noted in our post yesterday, historically, energy prices and equities have a positive correlation, that is, they move in the same direction. Intuitively this makes sense as a stronger global economic environment leads to a higher demand for energy resources. Since late 2013 this correlation broke down and energy prices began to move in the opposite direction of stocks. When January 2016 rolled around though, the correlation between oil and stocks once again turned positive.

Continue reading >>>

Understanding The Disconnect In The Correlation Between Oil And Stock Prices

Recently a number of commentators on the weekly business shows have commented oil prices and the stock market have been moving in the same direction during the month of January. On the few days oil and stocks moved in opposite directions, the conclusion was this would be a good thing for the overall market. Not wanting to single out any one specfic strategist, but this past Monday, Bill Stone, chief investment strategist at PNC Wealth Management, noted on CNBC, "it's not clear whether the selling will subside for now because of the tight correlation between stocks and oil prices, which he says should break at some point (emphasis added)." This comment is similar to a number of other strategists.

So what is the point then? As the below chart shows, going back to the mid 1980's the price of oil and the price of stocks have a positive correlation of .66. It only has been since October of 2013 that this correlation broke down and reversed. Since the October 2013 time period, the correlation between oil prices and stock prices has been a negative .74. In other words, market participants should be rooting for higher oil prices and a return to the positive correlation that has been evident over the long run. In all seriousness though, investors should be aware of the fact that there is a high positive correlation between oil and stock price movements.

From The Blog of HORAN Capital Advisors

A number of factors can influence the price of oil, but stronger demand in an environment of stable supply can cause oil prices to rise. This often occurs when stronger economic activity is present. What seems to be occurring today is lower oil prices face downward pressure due to the continued increase in supply in spite of a significant reduction in drilling rig count. The first chart below shows global demand has continued to increase; however, supply growth is greater than the growth in demand. The supply/demand imbalance does not come into balance until late 2016. The second chart shows rig count (maroon line) has declined by more than 60%, i.e., 1,216 rigs, yet supply (green line) has continued to grow.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

In conclusion, we believe the recent disconnect in the movement between stock and oil prices is influenced more by excess supply and not a decline in demand. The positive to draw from this one data point is economic activity is not contracting if one evaluates the oil consumption part of the economy. If lower oil prices continue to be realized, at least in the first half of this year, this should be a tailwind that supports consumer spending in other areas besides energy and supports steady economic growth this year.

Sentiment Supportive Of Further Equity Gains

Two Fridays ago (1/15/2016) I highlighted sentiment readings often associated with an oversold equity market. Two days later, Wednesday of this past week, the S&P 500 index bottomed and staged a turnaround, generating its first weekly gain of the year, up 1.4%. A number of the sentiment measures improved with this turnaround, yet two positive return days does not qualify as a new bull market. Below is a table consisting of a number of sentiment indicators comparing readings from two weeks ago to the just concluded week.

From The Blog of HORAN Capital Advisors

The equity put/call ratio, the Vix and the Vix/10-year Treasury Yield ratio improved. Although improvement was seen in the P/C ratio, the 21-day moving average of the ratio moved higher to .79 versus last week's average level of .76 as can be seen in the below chart. A sustained move lower in this average is associated with increasing equity prices. With the elevated level of this average, a turn lower is a high probability.

From The Blog of HORAN Capital Advisors

One recent concern for investors is the spike in volatility experienced by the market. A part of the heightened awareness has been the lack of downside volatility from 2011 until the August 2015 correction. Since 2011 the Vix index has traded at a lower average level of 15.80 compared to the time period from 1995-2011 when the average was 20.96. As noted in several earlier blog posts, the Vix index is a measure of implied equity volatility. Higher levels in the Vix imply a higher level of market uncertainty or fear.

From The Blog of HORAN Capital Advisors

In an effort to compare the Vix to economic expectations, one can evaluate the Vix divided by the 10-year Treasury Yield. A number of factors can influence Treasury yields, but the perception is lower yields on longer term Treasuries are reflective of a weaker economic environment. As a result, one would want to see a lower Vix to 10-year ratio. As the table above noted, this ratio has declined over the last week.

From The Blog of HORAN Capital Advisors

Of importance is the fact this ratio has traded at a higher average level since 2011 at 7.49 versus 5.34 from 1995-2011. As can be seen in the Vix only chart above, the Vix has traded at a lower level since 2011. Consequently, the Vix/10 year ratio has been higher due to the lower level of the 10-year Treasury, indicating the market has been expecting a weaker economic environment. And the economy has been growing below its long term potential.

Lastly, the NAAIM Exposure Index is trading at a level notable for oversold markets. The NAAIM Exposure Index consist of a weekly survey of NAAIM member firms who are active money managers and provide a number which represents their overall equity exposure at the market close on a specific day of the week, currently Wednesdays. Responses are tallied and averaged to provide the average long (or short) position or all NAAIM managers, as a group.

From The Blog of HORAN Capital Advisors

This lower equity volatility translated into the market moving higher nearly unabated since 2011. August 2015 rolls around and breaks the nearly four year streak without a greater than 10% correction as the market fell 12.4%. A market recovery took hold into year end and another correction unfolded this month.

From The Blog of HORAN Capital Advisors

For a number of reasons I expect the equity market to experience higher volatility going forward. The core of the Federal Reserve's quantitative easing programs has ended and the Fed has embarked on a tightening program with December's rate increase, and this is likely to cause increased market volatility, but not all to the downside. The issues impacting the energy market are also negatively weighing on the market and investor sentiment. A difference between 2008/2009 and now is the fact the 08/09 issues were related to housing and ultimately negatively impacted the consumer. With the issues facing the energy sector, the outcome has been lower oil prices and this serves as a broad benefit for consumers. As Charles Schwab recently noted in a report, it would also be the first time a sharp decline in oil prices led to a recession.

From The Blog of HORAN Capital Advisors

The coming week will contain potentially market moving news. The Fed has a meeting scheduled with an announcement on Wednesday, the first estimate of fourth quarter GDP is reported on Friday and 44 companies report earnings this week. A number of energy, materials and industrial firms are included in the 44 announcements and the market will look to guidance for insight into potential economic growth ahead.

Ed Hyman And Dennis Stattman On Their International Outlook

Earlier this week Consuelo Mack of WealthTrack conducted Part II  of her interview (Part I highlighted last week) with legendary economist Ed Hyman, Chairman of Evercore ISI, and Dennis Stattman, fund manager on BlackRock's Global Allocation Fund. This interview occurred after the market weakness experienced during the first week of January so both guests were aware of the early year market contraction.

Ed Hyman believes the global issues facing economies are a result of growing too slowly and attributes this to the slowdown in China. This below potential growth rate leads to potential deflation and he cites the issues within the commodity sectors. His favored international market is Europe, but does acknowledge the benefits taking place in Japan after nearly 25 years of no growth in that country. He does believe China is the key for the broader emerging market arena and does think China's economic policies are moving in the right direction, i.e., getting growth in consumer demand and moving away from fixed asset investment. He cites good China sales data from Apple and Alibaba. His biggest worry is the issues in the Middle East as a result of the decline in oil prices and the negative impact this has on revenues for those countries.

Dennis Stattman is a pound the table bull on Japan. He notes that earnings growth and dividend growth for Japanese firms has left price earnings ratios for Japanese companies nearly unchanged. He cites Japan is the only major area where earnings revisions are positive. He does worry about the debt growth in China and the slowing of GDP growth in the country. Dennis' biggest worry is China experiences a large decline in tts currency and that adjustment negatively impacts other emerging markets. He believes a world of quantitative easing, asset prices in the QE countries inflate and economies do benefit. Hedging the currency exposure is an important factor for individuals investing in Japan though.

As with the Part I interview, this is a worthwhile viewing for readers.

Maximum Fear May Be Near

To say the least it has not been a rewarding start for investors in the equity markets so far in 2016. After the volatile downside move in equities today, the S&P 500 Index closed at 1,880, down 8% year to date. Intraday today the S&P 500 Index was down 3.3% and pierced the August low of 1,867 and finally closed down 2.1%. The market action has raised the investor fear level to near oversold levels, if not to a maximum oversold level.

The equity put/call (P/C) ratio spiked above 1.0 to 1.14. As I have noted in earlier posts, P/C ratios above 1.0 are representative of an oversold market. 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 by the individual investor.

From The Blog of HORAN Capital Advisors

A week ago I wrote about the VIX futures curve being in backwardation. Steeper backwardation has occurred after the market action today. Backwardaion took place near the market bottom on August 25, 2015. VIX backwardation is an indication traders expect volatility in the future to be lower than it is now. Historically, when this occurs, short term market rallies tend to result from this technical event.

From The Blog of HORAN Capital Advisors

Further, individual investor bullish sentiment fell four percentage points to 17.9% as reported by the American Association of Individual Investors earlier this week. The last time the reading was near this level was April 14, 2005 when bullish sentiment was reported at 16.5 and the S&P 500 Index was trading at 1,173. Investor sentiment is a contrarian indicator and this level of market pessimism is another sentiment measure that may mark another interim market bottom.

From The Blog of HORAN Capital Advisors

Scott Grannis, writer of the Calafia Beach Pundit blog and former Chief Economist at Western Asset Management, highlights other fear measures that readers may find useful in reviewing. His recent post includes commentary on the stress in the bond market and notes the higher liquidity in the markets today versus in 2008. As with most market sell offs, elevated fear levels are the fuel to the fire, yet can result in a market that becomes too oversold.

The Clarion Call On The Market

On Tuesday The Royal Bank of Scotland's credit chief, Andrew Roberts, made the clarion call to 'sell everything.' He predicts a cataclysmic year faces investors in 2016. A day earlier, a J.P Morgan equity strategist advised investors to sell any rally.

Investors are grappling with an increase in market volatility at the start of the New Year. After celebrating the end of a flat to mostly negative year in 2015, investors least expected the pace of the current January market pullback. As I discussed in this past weekend's post, A Difficult Beginning For The Market To Start The New Year, market swings of greater than 10% have been scarce since 2011. Essentially, the market steadily climbed higher for nearly four years until last August when the S&P 500 Index declined 12.4% from the May high. In other words, investors may have been conditioned to expect lower volatility from stock prices.

Earlier today, Alan Steel, Chairman of Alan Steel Asset Management, a Scotland-based investment firm, wrote the below succinct commentary about the current market environment and the accuracy of strategists' doomsday market predictions:

Continue reading >>>

Winter 2015 Investor Letter: Narrow Leadership And Heightened Volatility

In our recently published Winter 2015 Investor Letter we discuss the challenging year faced by investors in 2015. A number of notable events occurred in 2015, the market succumbed to a 10% correction after going nearly four years without one, the Federal Reserve raised interest rates for the first time in over nine years, and 2015 equity market returns were concentrated in a handful of names, those names have been referred to as the FANG stocks, Facebook, Amazon, Netflix and Google (now called Alphabet.) Our Investor Letter contains our thoughts on the coming year. These thoughts include commentary on oil, the US Dollar and recent economic activity.

From The Blog of HORAN Capital Advisors

For additional insight into our views for the market and economy, see our Investor Letter accessible at the below link.

• Winter 2015 Investor Letter

Ed Hyman: Halfway Through Current Expansion Cycle

Ed Hyman, Chairman of Evercore ISI, and rated the number one economist for 35 consecutive years by Institutional Investor, recently sat for Part One of a two part interview with Conseulo Mack of WealthTrack, which was aired a few days ago. Also participating in the interview was Dennis Stattman, the Portfolio Manager of Blackrock Global Allocation Fund.

Hyman pointed out many positives he has witnessed in his travels around the country and gleaned from Evercore ISI's business surveys. In short, Ed Hyman believes the U.S. economy is only halfway through its current expansion. He believes the consumer, employment and now broadly rising wages are some factors that continue to support slow but steady U.S. economic growth. The interview does point out his concerns as well.

Dennis Stattman on the other hand, believes greater opportunities for investors can be found in non-U.S. markets. His concern is the U.S. economy and market growth have been largely supported by the Fed's quantitative easing programs. The U.S. market began to stumble last year once the Fed pulled back on its QE endeavors. Additionally, Dennis Stattman believes U.S. firms will find it difficult to grow profits in an environment where corporate profits as a percentage of GDP are at historically high levels. Dennis did not say this, but if one believes QE inflated U.S. equity prices, the European Central Bank and Bank of Japan continue to implement QE strategies.

The interview runs about 30 minutes and is a worthwhile viewing for readers. I will post Part Two when available, likely next weekend.

A Difficult Beginning For The Market To Start The New Year And What Investors Might Now Expect

For stock investors, the poor market performance to start the new year was not what market participants expected. Most readers have seen the statistic that the 5.96% decline in the S&P 500 Index so far this year is the worst market performance to begin a year on record. In an effort to keep things somewhat in perspective,

• since 1928 there have been 421 worse 5-day periods for the S&P 500 Index. (h/t @RyanDetrick)

• in August, the 5-day market decline was -11%.

Influencing investor perceptions is the fact not many asset class categories performed well last year. Except for the FANG stocks (Facebook, Amazon, Netflix and Google (now called Alphabet)) diversifying one's investments across asset classes did not generate expected results and we commented on this in our last post of 2015. Coincident to the narrow market leadership has been the fact the S&P 500 Index has moved higher since the end of the financial crisis in a nearly uninterrupted climb. Until mid-year last year, the S&P 500 had gone nearly four years without a greater than 10% market correction.

From The Blog of HORAN Capital Advisors

Prior to the last correction in August, two back to back sizable declines occurred in 2010 and 2011. One factor evident subsequent to 2011 was the lower volatility exhibited by the market, i.e., lower daily price swings in the market. This is seen in the chart below. The two circles on the chart mark  the period around the time of the 2010 and 2011 corrections.

From The Blog of HORAN Capital Advisors

One theme we believe will play out over the course of this year is a market that has a more normal, that is, higher level of volatility on a daily basis. The start of this year is proving this to be the case.

There are several factors at play that are likely to be a catalyst for the higher level of market swings. The first and probably most significant one is the late stage of this economic expansion with our belief the economy is in the early last third of the cycle. This raises the question of how late in the cycle is the economy. At issue is the divergence in the ISM manufacturing and non-manufacturing indexes.

From The Blog of HORAN Capital Advisors

The ISM Manufacturing Index has fallen below 50 and is evidence of contraction in the manufacturing segment of the economy. According to the report, "contraction in new orders, production, employment and raw materials inventories accounted for the overall softness in December." In reviewing some of the respondents comments in the report, many of them referenced weakness in energy and commodities as an issue.

With respect to the ISM Non-Manufacturing Index, Charles Schwab notes, "With the service sector making up roughly 88% of the U.S. economy according to HFE Research, the easy answer is that the manufacturing sector (the other 12%) will be dragged along. But the cautionary tale is that the manufacturing side of the economy in the past has been a leading indicator; so we do not have blinders on to the risk of a recession if services were to falter. But the consumer-oriented services sector does generally benefit from lower energy prices; while the hit to the energy sector would lessen if oil prices were to stabilize." We also believe the consumer is in good financial shape and will benefit from their improved balance sheets and the benefit derived from lower energy costs.

The second factor is the Fed. In December the Fed increased the Fed Funds rate by .25% or 25 basis points. Historically, when the Fed embarks on a tightening cycle, the market stumbles at the first rate hike. A rate increase from this low of an interest rate level historically does not hinder economic growth. The uncertainty with this rate tightening cycle is the fact economic growth since the financial crisis has been highly supported by quantitative easing activities. Subsequent to the Fed rate increase, the yield curve has actually begun to flatten with longer term rates declining in spite of an increase in short term rates.

From The Blog of HORAN Capital Advisors

So where does this lead us with respect to the equity markets? As a backdrop,

• 240 stocks in the S&P 500 Index are down more than 20% from their 52 week high

• another 160 stocks are down between 10-20% from their 52 week high

• in other words 80% of S&P 500 stocks are down greater than 10% from their 52 week high

• the market is down 9.6% compared to the high reached in May 2015

• if the market falls just 2.8% it will reach the low of August 25th (1,867)

From a technical and sentiment perspective the market is certainly approaching, if not near, oversold levels. With Friday's market close, the VIX futures curve went into backwardation. This occurred near the market bottom on August 22, 2015. VIX backwardation is an indication traders expect volatility in the future to be lower than it is now. Historically, when this occurs, short term market rallies tend to result from this technical event.

From The Blog of HORAN Capital Advisors

The American Association of Individual Investors' report last week showed, in addition to a decline in bullish sentiment to a level last reached in July 2015, the bull/bear spread came in at -16.1% versus the prior week's level of +1.5%. This week's reading is the most bearish the spread has been since July of 2015 as well.

From The Blog of HORAN Capital Advisors

Source: AAII

The equity put/call ratio spiked higher to .93 on Friday. This ratio measures the sentiment of investors 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 by investors. Levels above 1.0 are most associated with an oversold equity market.

From The Blog of HORAN Capital Advisors

The next two charts show the percentage of S&P 500 stocks trading above their 50 and 200 day moving averages. Both charts show the low percentages occur near market levels which have historically been indicative of market bottoms.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Lastly, a look at the market itself. In addition to the above noted technical and sentiment indicators, the below chart shows the market is nearing an oversold level. The technical money flow index (MFI) is nearing the oversold level, less than 20. The caveat is strong market downtrends can result in the MFI remaining below 20 for an extended period of time. The current MFI level is near the level reached at the August market low. On the other hand, both the MACD and On Balance Volume indicators are not indicating a market ready to bounce. For a number of other reasons also, but these two indicators may indicate the market retests the low reached in August, i.e., S&P 500 Index level 1,867. As noted at the outset of this post, to reach the August low, the market would need to decline only 55 points or 2.8% from Friday's close.

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In summary, Burt White, Chief Investment Officer at LPL Research, provided good commentary for investors as they navigate this market environment.

"Risks remain, however, as continued declines in energy prices have delayed vital capital investment by a major segment of the U.S. economy, corporate earnings remain muted, and manufacturing remains weighed down by tepid global demand and a stronger dollar. Although the turmoil in the oil markets remains a top concern, the lower prices should help speed up the painful supply adjustment process and may bring about greater stability as the year unfolds. Should the supply-demand imbalance in energy stabilize as we expect, this could be a potential catalyst for additional capital spending and accelerated profit growth as 2016 progresses." 

"Volatility has always been a part of investing and always will be. In fact, over the last 15 years, every calendar year has seen at least one pullback of at least 6% and a median correction of 14%. So while volatility is normal (and even expected), it is always nerve-wracking. These short-term market flare-ups are often quick and severe, but fueled by feelings of fear and concern over perceived risks that may not be actual threats. We expect volatility to remain heightened for the remainder of 2016, which is common as the business cycle ages, and in turn, makes sticking to your long-term investment plans even more important to avoid locking in losses and missing out on opportunities. This current pullback...could continue over the short term as fear and concern trump much of the good news coming from the U.S. economy. What remains as the key to weathering these short-term bouts of volatility is a commitment to a well-formulated plan, a long-term focus, and good headphones to tune out the noise of short-term negativity."

Tobin's Q Below 1.0 In Q3 2015

As of the third quarter the Tobin's Q ratio declined below 1.0. The Tobin Q ratio was originally formulated by Yale University professor James Tobin. James Tobin is a Nobel laureate in economics. The theory behind the ratio is the combined market value of companies on the stock market should be equal to the replacement cost of company assets. The Q ratio is defined as the ratio of the market value of a firm to the replacement cost of its assets. When the stock market trades at a ‘discount’ to the replacement cost of its assets, the market is inexpensive. This discount is when the ratio is below 1.0. When the ratio is above 1.0, the market trades at a premium to its replacement cost. As the below chart shows, this reading below 1.0 is the first since the Q ratio equaled .986 at the end of Q2 2013.

From The Blog of HORAN Capital Advisors

Since 1990 the average Q ratio level is .94, but certainly skewed by the high Q reached at the height of the technology bubble in 2000. Going back to 1950, the long run average Q ratio is approximately .70. The Tobin Q ratio is not a short term timing indicator; however, it does allow one to evaluate over and undervaluation of the market. In terms of expected returns, the below chart shows future 10-year forward returns at various Q levels. Evident from the chart is lower Q levels are associated with better forward returns.

From The Blog of HORAN Capital Advisors

What are the implications with "Q" values greater than or less than 1.0,? According to the website, Money Terms,

"A Tobin's Q of more than one means that the market value of assets (as reflected in share prices) is greater than their replacement cost. This means it is likely that capex will create wealth for shareholders. This means companies should increase capex, raising more money to do so if necessary, but should not make acquisitions. This should reduce share prices and increase asset prices, pushing Q towards one." 

"A Tobin's Q of less than one suggests that the market value of the assets is less than replacement cost, making acquisitions cheaper than capex; buying cheaper than setting up from scratch. This should increase share prices and reduce asset prices, again pushing Q towards one."