U.S. Federal Budget At Critical Juncture

The title of this post is a little misleading since Congress hasn't passed a federal budget in over three years. Nonetheless, one is able to gain insight into the actual revenue and expenses going into and out of Washington and it is not positive.

A recent presentation by Mary Meeker, general partner at Kleiner Perkins Caufield & Byers, at the Ira Sohn Foundation Conference titled USA, Inc, provides detail on the out of balance nature of the federal government's budget. Some highlights from her presentation:

• Expenses exceed revenue.

From The Blog of HORAN Capital Advisors

• Unfunded liabilities.

From The Blog of HORAN Capital Advisors

• Percentage of tax payers versus those receiving government benefits.

From The Blog of HORAN Capital Advisors

The entire USA, Inc presentation is a worthwhile and eyeopening read.

h/t: Dealbook: New York Times

Apple: Anticipated Future Price Action

An article written by Ali Meshkati on his Zenpenny site provides his take on the potential price action for Apple (AAPL) in the coming weeks. He notes:

"10-28-12: The best case scenario with AAPL going forward is a period of sideways chop. Those highs at $700 won't be challenged for some time. The low created on Friday will likely be broken within the next few weeks, following a move up to $630 - $640 to convince the convincible that the iPhone 6 & 7 mean a $1,000 stock price in the near future.

The path that AAPL is likely to take has been revealed in the not to distant past. Check out box A. A high volume reversal that resulted in a gap and eventual failure.

While I don't expect a gap up here, I expect a retrace of a portion of the recent losses that should give AAPL enough new blood to make heads roll in the weeks ahead.

$520 - $550 remain the likely target for a solid buy point."

(click chart to enlarge)

From The Blog of HORAN Capital Advisors

Source: Zenpenny

HORAN Begins Financial Planning Blog

A few days ago, HORAN's Director of Financial Planning, Michael Napier, joined the blogosphere by starting HORAN's financial planning blog. As Michael notes in his initial post,

"Everybody blogs. In fact, it is estimated that close to 44 million blogs are created each year. Doing the math, that is nearly one new blog per second! So why am I jumping into the blogosphere? To help you get one step closer to achieving your financial goals in easy-to-understand language.

Two of the biggest challenges facing Americans today are access to great health care and the discipline to sustain wealth management strategies such as making smart decisions about investing and wealth transfer. My focus will primarily be sharing topics I come across on a daily basis to help your financial life. Strategies in tax- savings, estate planning, college savings, budgeting, insurance and retirement will be discussed."

Subsequent to the initial post, he wrote two articles readers will find of interest.

• A Little- Known Financial Planning Strategy
• Financial Planning Must Do: Check and Double-Check Your Beneficiary Designations

The RSS Feed for all of the HORAN blogs can be found here: HORAN RSS Blog Feed

P/E Level For S&P 500 Index At Level Not Seen Since 1990s

The Chart of the Day charting service recently noted the valuation or P/E for the S&P 500 Index is at levels last seen in the early 1990s. Importantly for investors though is valuation alone does not make a particular equity attractive. As the below chart notes, valuations can certainly get cheaper. Chart of the Day noted in the commentary to the below chart:

"[The] chart illustrates the price to earnings ratio (PE ratio) from 1900 to present. Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to extraordinary levels during the financial crisis (late 2000s). Since the early 2000s, the PE ratio has been trending lower with the very significant but relatively brief exception that was the financial crisis. More recently, the PE ratio has moved slightly higher. It is worth noting, however, that even with this recent uptick, the PE ratio still remains at a level not often seen since 1990."

From The Blog of HORAN Capital Advisors

Source: Chart of the Day

Companies Becoming More Cautious As Fiscal Cliff Nears

Much is being made about the impact on the economy in light of the impending "fiscal cliff" in the U.S. Most strategists agree the impact on the economy will be significantly contractionary if the U.S. goes over this so-called cliff. In reality though, the negative impact of the cliff is already being felt and it appears businesses are positioning themselves for a potential worst case outcome.

Over the course of the last week or so, many writers have referenced the chart of manufacturers new orders of capital goods. The below chart contains "new orders ex defense" compared against the S&P 500 Index. As can be seen, this decline in capex spending has been a precursor to a potential recession. The current spending level is certainly flashing a warning. The chart in the article at this link shows capex spending compared to economic growth or GDP. In short, Washington is playing with fire as it relates to the current economy and if there recent actions are an indication, the administration and Congress do not understand how businesses plan and operate. Businesses hate uncertainty.

From The Blog of HORAN Capital Advisors

Investors Continue To Reduce U.S. Equity Exposure

Investors continue to shun U.S. equity investments as noted in the below chart. In spite of this data most U.S. equity indexes have continued to move higher this year. As we have noted in several earlier posts, it appears investors are allocating increasingly more of their investment assets to fixed income funds. Then what is driving U.S. equity prices higher?

From The Blog of HORAN Capital Advisors

As discussed in our third quarter investor letter, the Federal Reserve's Flow of Funds Z.1 quarterly report, shows corporations had negative net equity issuance of $218 billion in 2011. Currently, net equity issuance is running at an annual rate of negative $259.5 billion through the second quarter of this year. In other words, one reason the equity market continues to move higher is the fact companies are reducing the supply of available equity in the market place. This has been accomplished via stock repurchases. Another factor contributing to negative equity issuance is the increase in the number of corporate acquisitions by publicly traded companies and private equity firms. That being said, if demand for equities stays the same and available equity supply continues to decline, equity prices will trend higher. In 2006 and 2007, net equity issuance was nearly negative $1 trillion which preceded the peak of the market in 2008. Corporations seem to be more confident in buying their own shares than investing in future growth.

Certainly, Q3 earnings reports are anything but stellar. However, the risk/reward of fixed income investments does not seem to favor bond investors at this point in time.

Steven Romick Interview On WealthTrack: Focusing On High Quality

The below video contains a rare interview with Steven Romick, portfolio manager of the FPA Crescent Fund (FPACX), and Consuelo Mack of WealthTrack. Romick provides insight into his investment approach that includes his current views surrounding his portfolio's current construction. In large part, he is most concerned about the consequences of the money printing that is currently taking place by the monetary authorities around the globe. As he notes, this appears to be a grand experiment that could end in disaster. He believes this is more than "kicking the can down the road", but more like a snowball rolling downhill. As he and others have noted, Ben Bernanke indicated the Fed's current approach is a little like "learning by doing." Not too comforting. From an equity investing perspective, he is focusing on the highest quality companies. He believes with this type of company, it isn't whether they will grow, but more a question of by how much. In his mind, it is more about preparing for the worst and hoping for the best. In spite of his concerns, he believes there is value in high quality global companies.

Investor Sentiment Near Lows Seen Last Summer

The investor sentiment survey, a contrarian indicator, released today by the American Association of Individual Investors noted the bearish sentiment level increased by 5.7 percentage points to 44.55%. This level of bearishness was last seen this past summer when the S&P was trading in the low 1,300s. Bullish sentiment fell to 28.66%, also at levels seen this past summer. In spite of this level of sentiment negativity, the S&P has continued to move higher. This higher move in the market is typical of a market climbing the proverbial "wall of worry". If companies continue to disappoint on earnings though as they have tonight, the market advance could be nearing an end in the short term.

From The Blog of HORAN Capital Advisors

Investor Letter: 3rd Quarter 2012

At the beginning of the third quarter, investors following the “sell in May” strategy felt vindicated as the S&P 500 Index declined over 9.0% from May 1st to June 4th. The June 4th date turned out to be the intra-year market low and the equity rally was almost uninhibited throughout the remainder of the third quarter. The rising tide seemed to lift all markets during the quarter.

As noted in our Third Quarter Investor Letter, in spite of the strong market advance, the Federal Reserve felt compelled to institute a third round of quantitative easing (QE3)in the third quarter. Maintaining loose monetary policy has not been as effective as the Fed would hope during this household and corporate deleveraging cycle. Companies have been vocal in regard to their greater concern about the future of tax and regulatory policies.

As we look ahead, we are mindful of near term potential risks, i.e., the U.S. fiscal cliff, Europe struggling with sovereign debt and growth issues, heightened Middle East tension and a more muted outlook for third quarter corporate earnings. We are positioned for a slower economic growth environment. We see some signs for long-term optimism as housing seems to have regained some footing, energy independence is increasingly possible and the repatriation of U.S. jobs is gaining traction. Longer term we continue to believe equities will be a strong performing asset class supported by compelling long term valuations.

The entire Letter can be accessed directly from our website at the following link: 3rd Quarter 2012 Investor Letter.

More Weakness Seen With Modern Portfolio Theory

Niels Jensen's, of Absolute Return Partners, market letter to investors notes how Modern Portfolio Theory (MPT) has become less effective over time. Over the past few years we have written several posts (here and here) on the problems with MPT. One chart in the Jensen's market letter displays the increasing correlation between asset classes that has developed since 2000 thus limiting the effectiveness of diversification as outlined in Modern Portfolio Theory.

From The Blog of HORAN Capital Advisors

Additionally, the market letter notes the outperformance of "quality" stocks versus say growth or value. As the letter states, quality refers to the strength of a company's balance sheet as well as the sustainability of its dividend policy.

From The Blog of HORAN Capital Advisors

A key for investors is to understand the approach taken by their investment manager in constructing their investment portfolio.

Source:

When Career Risk Reigns (PDF)
Absolute Return Partners LLP
By: Niels J. Jensen
October 2012
http://www.arpllp.com/core_files/The_Absolute_Return_Letter_1012.pdf

Weak CEO Confidence, Weaker Market Ahead?

Last week The Conference Board released its CEO Confidence Measure and noted a decline to 42 in the third quarter versus 47 in Q2. A reading below 50 reflects more negative responses than positive ones. The report notes a third of the CEO's surveyed indicated they were curtailing capital spending plans. Lynn Franco, Director of Economic Indicators at The Conference Board noted,

"This latest report reflects ongoing concern about the strength of the economy. CEOs’ assessment of current conditions remains weak and they have grown increasingly pessimistic about the short-term outlook. Sluggish growth and a persistent cloud of uncertainty have played a role in CEOs curtailing spending plans this year.”

Historically, when this Measure reached this level of pessimism, the equity market was not too far from a near term peak.

From The Blog of HORAN Capital Advisors

Dividend Payments Increase In Third Quarter

In a report recently released by Standard & Poor's, they note more companies increased their dividend payments in the third quarter versus the same quarter last year. The number of positive actions (439) equals the number in Q3 2007. The report notes:

"...dividend net increases (increases less decreases) were $8.8 billion in the third quarter of 2012, setting what is believed to be a new record dividend quarterly payout in aggregate dollars for U.S. domestic listed common stock issues..."

From The Blog of HORAN Capital Advisors

 Data Source: Standard & Poor's

As we will discuss in our soon to be released third quarter investor letter, investors have been searching for yield, especially retired investors, and have sought out dividend paying stocks. If Congress allows the budget to go over the so called fiscal cliff, retired investors will be harmed significantly due to the tax increase on dividends.The Sober Look website notes beginning in 2013, the U.S. will have the highest top dividend tax rate in the world if the tax increases subject to the fiscal cliff go into effect.

From The Blog of HORAN Capital Advisors

Food Stamp Participation Versus Labor Force Participation

Central banks around the world are doing all they can to pump liquidity into their respective economies. To date though, their actions are having limited effectiveness when it comes to improving economic growth. One consequence of the slow growth in the U.S. is the dramatic increase in food stamp usage. The increased food stamp usage also seems to translate into a lower labor force participation rate as well.

From The Blog of HORAN Capital Advisors

Source:

Boxing Match: Central Banks vs. the Economy
Fidelity Viewpoints
By: Jurrien Timmer, Portfolio Manager
September 16, 2012
https://news.fidelity.com/news/article.jhtml?guid=/FidelityNewsPage/pages/fidelity-central-banks-vs-the-economy&topic=economy

Private Fixed Investment Signaling A Recession?

An article from three months ago on the SentimentCharts website noted the slowing YOY change in Private Fixed Investment (FPI) had signaled all seven U.S. recession over the last 45 years. The data used in the SentimentCharts' article was through the first quarter of the year and an increase in the growth of FPI was seen. One quarter later though, through the second quarter, the YOY growth in FPI is slowing.

From The Blog of HORAN Capital Advisors

Private Fixed Investment is an element that goes into the calculation of GDP. In the BEA's second release of second quarter GDP, they noted weakness in fixed investment as a cause for the deceleration of Q2 GDP.

"The deceleration in real GDP in the second quarter primarily reflected decelerations in PCE, in nonresidential fixed investment, and in residential fixed investment that were partly offset by a smaller decrease in federal government spending, an acceleration in exports, and a smaller decrease in private inventory investment."

The slowing growth in fixed investment along with a significant increase in the number of companies lowering Q3 earnings guidance are just a couple of factors that should be a cause for concern for investors.

Strong Stock Buyback Activity in Q2

Standard & Poor's recently reported the buyback data for the S&P 500 Index for the second quarter. Noted in their release is buybacks increased 32.5% in Q2 versus Q1. Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices noted,

"The last time we have seen this level of activity was during the pre-recession heydays of 2005-2007. While the second quarter produced a broad decline in the equity markets, companies used the quarter to increase holdings, reduce share counts, and add a tail-wind to their eps during a quarter which set an operating record for profits."

From The Blog of HORAN Capital Advisors

Notable buyback amounts in the quarter were:

• Johnson & Johnson (JNJ): $12.9 billion
• AT&T (T): $2.6 billion
• American International Group (AIG): $2 billion

Investors need to analyze 3Q earnings reports carefully in order to determine the reasons behind potentially higher EPS that may be reported. S&P also noted they are seeing over 80 companies increase buyback activity in Q3. This lower share count will artificially inflate reported EPS. Reviewing a companies absolute earnings should be a focus of investors. Factset recently noted,

"So far, 103 companies in the index have provided guidance for the third quarter. Of those, 80% have guided  below Wall Street consensus estimates, according to John Butters, senior earnings analyst at FactSet. That’s the most negative outlook since FactSet began tracking the figures in the first quarter of 2006."

Disclosure: Long JNJ

Transport Company Warnings Not Positive Sign For Global Economic Growth

Over the course of the last two days, both FedEx (FDX) and Norfolk Southern (NSC) have issued significantly lower earnings guidance. In the case of FDX, the warning may be more of a concern given the global nature of their business. Additionally, the link between FedEx package shipments and YOY GDP growth suggests the global economy is experiencing a significant slowdown.

From The Blog of HORAN Capital Advisors

In the case of Norfolk Southern, after today's market close, the company lowered their 3Q earnings guidance to a range of $1.18 - $1.25. This compares to original 3Q guidance of $1.62 and 3q 2011 earnings of $1.59. Not surprisingly, the stock initially fell over 6% in after hours trading to $68 share before recovering to $69 per share. The Wednesday closing price for NSC was $72.69.

From The Blog of HORAN Capital Advisors

A recent Wall Street Journal report tht discussed the FDX earnings revision noted, "It isn't just FedEx. Data gathered by the CPB Netherlands Bureau for Economic Policy Analysis show that global trade volumes grew an unusually low 2.6% in the second quarter compared with a year earlier; the average pace over the past 20 years has been 6.1%. The two major West Coast ports, the ports of Los Angeles and of Long Beach, Calif., reported that outbound container volumes fell by 4.1% in August from a year earlier. That was the steepest drop since September 2009."

The lower earnings guidance by both of these companies and the West Coast port data are indications of slower economic growth, if not growth that is more indicative of a recessionary environment.

Disclosure: Long NSC

Jason Trennert: Short Term Bearish

Jason Trennert, chief investment strategist at Strategas Research Partners, recently discussed his views on the economy and believes the recent economic data is typically associated with an economy that is in a recession. In his Barron's article this week, Long-Term Bull, Short-Term Bear ($), Trennert noted,

"Profit margins are two standard deviations above the mean, and nominal GDP growth of 3.1% in this year's first half was at a level normally associated with a recession."

As he discusses in the below video, much of the earnings strength seen by companies has come from expense reduction (margin expansion) and not top line revenue growth. He believes current policies coming out of Washington are not growth oriented, the impending fiscal cliff being one such example.

Federal Reserve Dominant Buyer Of Treasuries

An end result of the Federal Reserve's quantitative easing programs, including operation twist, is the Fed's balance sheet has swelled with the growth in U.S. treasury holdings. In 2011, the Fed purchased over 60% of all the treasuries issued by the government. A recent Bloomberg comment notes the Fed now owns over 37% of all treasuries with maturities greater than 5-years.

From The Blog of HORAN Capital Advisors

Source: Bloomberg Surveillance

This is certainly a path that is unsustainable before reaching a tipping point. In order to continue down this path, the dollar printing press will need to run at full speed with an end result a further weakening of the U.S Dollar and consequent higher inflation.

Dow's Recent Advance Below Average In Duration And Magnitude

Even with all the Fed's intervention and their attempt to force investors into risk assets, The Chart of the Day's recent market chart notes the current rally is both below average in duration and magnitude.

"The Dow made another post-financial crisis rally high Thursday on the news that the Fed will embark on a third round of quantitative easing (a.k.a. QE3). To provide some perspective on the current Dow rally, all major market rallies of the last 112 years are plotted on today's chart. Each dot represents a major stock market rally as measured by the Dow -- with a rally being defined as an advance that followed a 15% correction (i.e. a major correction). As today's chart illustrates, the Dow has begun a major rally 28 times over the past 112 years which equates to an average of one rally every four years. Also, most major rallies (78%) resulted in a gain of between 30% and 150% (29.8% to 150.5% to be exact) and lasted between 200 and 800 trading days (9.5 months to 3.2 years) -- highlighted in today's chart with a light blue shaded box. As it stands right now, the current Dow rally (hollow red dot labeled you are here) which began in October 2011 (since it followed a 16.8% correction), would be classified as well below average in both duration and magnitude."

From The Blog of HORAN Capital Advisors

Source: Chart of the Day

Jeffrey Gundlach: I Doubt You're Going To See Lost Decade In Equities

Fixed income manager, Jeffry Gundlach, sat down for an interview on Bloomberg recently. In the interview he discusses the risk that has developed in the bond market, specifically in treasuries. His firm DoubleLine, is considering expanding into equity fund management as well.

h/t: Abnormal Returns

Revenue And Earnings Growth Continue To Slow

One of the services provided by Thomson Reuters (TRI) is they aggregate financial data from analyst. TRI recently updated/aggregated all the analyst data as it relates to earnings and revenues for the S&P 500 Index companies for the third quarter. TRI notes:

"...companies in the S&P 500 are likely to post the slowest annual revenue growth rate [for Q3] in the last decade (barring the 2008/2009 financial crisis) and the trend seems to be getting worse, with more disappointments in store."

From The Blog of HORAN Capital Advisors

In order for companies to continue achieving earnings growth, they have focused on the cost side of their business. Unfortunately, companies can only cut costs for so long before this avenue to increase earnings comes to an end. Well, this reality may be setting in for Q3 2012 earnings. As the below chart details, Q3 earnings are expected to decline by 2.0%. It is likely, Q4 earnings are revised lower as well. The second chart shows the trend in fourth quarter earnings growth.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

TRI discusses the potential consequences of this slowdown in the below video.


Source:

Idea of the Week: Analysts Cutting Their Q3 Revenue Forecasts
Thomson Reuters: Alpha Now
By: John Kozey
September 12, 2012
http://alphanow.thomsonreuters.com/2012/09/idea-of-the-week-analysts-cutting-their-q3-revenue-forecasts/

Disclosure: our firm is long TRI

As of August Year To Date Dividend Payers' Return Trails Non Payers

On a year to date basis ending August 31, 2012, the return of the dividend payers in the S&P 500 Index trails the return of the non payers. The average return of the payers equals 10.37% versus 12.70% for the non payers. For the 12-month period the payers average return totals 14.70% versus 10.01% for the non payers. On a weighted basis though, the S&P 500 Index return equals 18.00% versus the 14.70% for the payers. Apple's (AAPL) return for the eight and twelve month periods has contributed 2.11% and 2.32% respectively, to the indexes overall return for those time periods.

From The Blog of HORAN Capital Advisors

Data Source: Standard & Poor's

Unemployment Rate Down Due To Participation Rate Decline

The employment situation report released this morning indicated non-farm payrolls increased by 96,000 versus an estimated increase of 125,000. The unemployment rate declined to 8.1% versus 8.3% in the prior month. The total number of unemployed remained at 12.5 million people so one would not expect the unemployment rate to decline. However, the decline in the rate is due entirely to the fact 368,000 individuals dropped out of the labor force. The participation rate fell to 6.5%, the lowest level since 1981.

From The Blog of HORAN Capital Advisors

The employment to population ratio of 58.3% declined slightly from the July level. This ratio has remained relatively flat since the end of the recession as little job growth has been seen in the economy.

From The Blog of HORAN Capital Advisors

Recession Risk In U.S. Rising But Still Low

From a business cycle perspective, Fidelity recently released a report that indicated the risk of a recession in the U.S. was rising. Although the rising recession risk is low, the report cited weak "external" factors as the cause. Also, these weak external factors may be impacting company earnings expectations as noted in yesterday's post: Companies Lowering Earnings Guidance For Third Quarter.

From The Blog of HORAN Capital Advisors

In spite of this higher risk, the U.S. and Japan remain in the mid-cycle expansion phase, while China is contracting.

From The Blog of HORAN Capital Advisors

Importantly for investors, one question being ask is where should investment dollars be allocated if the economy is nearing a slowdown.  Our post, Sector Rotation and The Economic Cycle, will provide some insight. Clearly, the U.S. economy is slowing. The Bureau of Economic Analysis released the second revision of GDP last Wednesday and it estimates GDP growth in the second quarter came in at 1.7%. This compares to 2.0% real GDP growth in the first quarter.

Source:

Business cycle update: recession risks rose
Fidelity Viewpoints
By: Dirk Hofschire, CFA, SVP, Asset Allocation Research, and Lisa Emsbo-Mattingly, Director of Asset Allocation Research
August 24, 2012
https://www.fidelity.com/viewpoints/market-and-economic-insights/august-business-cycle-update

Companies Lowering Earnings Guidance For Third Quarter

In spite of the high level of negative earnings guidance issued by companies for the third quarter, the market is shaking of this news and moving higher. Factset reports,

"For Q3 2012, 80 S&P 500 companies have issued negative EPS guidance while 21 companies have issued positive EPS guidance. If 80 is the final number of companies issuing negative EPS guidance for the quarter, it will mark the second highest number for a quarter during the past three years, only trailing the number recorded in Q4 2011 (84). If 21 is the final number of companies issuing positive guidance for the quarter, it will mark the lowest number of companies for a quarter since FactSet began tracking guidance in Q1 2006.

"At the sector level (with a minimum of five companies issuing quarterly EPS guidance), the Health Care (100%) and Materials (100%) sectors have the highest percentages of companies that have issued negative EPS preannouncements, while the Industrials (50%) and Consumer Staples (50%) sectors have the highest percentage of companies that have issued positive EPS preannouncements."

From The Blog of HORAN Capital Advisors

Factset goes on to note,

"Although the percentage of negative preannouncements is running at an all-time high, the market is not punishing the price performance of these stocks in the short term. For the 80 companies that have issued negative EPS guidance for Q3 2012 to date, the average price change (2 days before the guidance was issued through 2 days after the guidance was issued) has been +0.2%. This percentage is well above the average over the past five years of -1.8%. Just under half of the companies (38) that have issued negative guidance have recorded an increase in price during this time frame. Ten of these companies witnessed a double-digit increase in price.

"For companies that have issued positive guidance, the story has been even better. Of the 21 companies that have issued positive EPS guidance for Q3 2012, the average price increase has been +6.5%. This percentage is also well above the average over the past five years of +2.6%."

From The Blog of HORAN Capital Advisors

Eventually, companies will need to generate top and bottom line growth in order to support a continued advance in the market.

Source:

Guidance (EPS)
Factset
By: John Butters, Senior Earnings Analyst
August 31, 2012
http://www.factset.com/websitefiles/PDFs/guidance/guidance_8.31.12

Where Hedge Funds Are Allocating Their Investments

Broadly, hedge funds have mostly trailed their market benchmarks; however, investors may find interest in tracking changes in positions and sectors for the hedge fund group. Investors should keep in mind that hedge fund positions are reported once a quarter and the report can be as late as 45 days following a quarter. Consequently, a fund's report may not be reflective of the fund's current allocations.

A recent Factset report notes changes in hedge fund positions and sector allocations in the second quarter. Highlights from the report:

• The fifty largest hedge funds increased their equity exposure by 3% and forty-five of the fifty managers showed an increase in equity assets in Q2 2012.

• Apple (AAPL) was present in the majority of fund portfolios and was the top holding of 24% of the 50 hedge fund companies.

• Hedge fund companies were most active in increasing their allocations to Procter & Gamble (PG) and BP PLC (BP) in Q2 2012.

• Citigroup (C) experienced the largest equity outflows, but, relative to starting portfolio values, Cisco (CSCO) and Crown Castle International (CCI) experienced larger declines (-29.5% and -24.3%, respectively).

• Facebook (FB) marked the largest new position over the quarter, but its ending weight in the aggregate portfolio amounted to less than 0.1%.

From a country and sector perspective, the U.S. market attracted the most interest. Energy, technology and staples were the favored sectors.

From The Blog of HORAN Capital Advisors

Source:

Hedge Fund Ownership: Quarterly Highlights, Q2 2012
Factset
By: Michael Amenta, Research Analyst
August 22, 2012
http://www.factset.com/websitefiles/PDFs/hedgefund_ownership/hedgefund_ownership_8.22.12

Disclosure: Our firm is long PG

Changing Tax Rates And Dividend Paying Stock Performance

With the looming fiscal cliff facing investors at the start of 2013, the marginal tax rate on dividends would increase to as high as 43.4% versus the current 15% rate. Investors are asking if this substantial increase will negatively impact the performance of dividend paying stocks. Copeland Capital Management recently published a white paper analyzing the impact of changing tax rates and the performance of dividend paying stocks vis-à-vis the overall market. The firm's research concluded:

• The performance of dividend-oriented strategies...did not demonstrate any significant relationship with tax rates during years when significant changes were enacted.

•  Corporate dividend policies also showed no relationship with changes in tax rates.

•  The performance of dividend growth stocks appears to be more closely linked with the economic cycle than either absolute tax rates or changes in tax rates.

The below tables detail the calendar year returns during changing tax rate environments. In the second table, as tax rates declined from 2002 to 2003, the market actually outperformed the payers and growers. The research paper notes market upturns following economic downturns generally favor lower quality names as the economy begins to improve. In short, tax rates had less of an impact than the economic cycle itself.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Source

Copeland White paper I: Dividends and Tax Rates (PDF)
By: David McGonigle
Copeland Capital Management
June 30, 2012
http://www.copelandcapital.com/PDF/Copeland_White_Paper_I_Dividends_and_Tax_Rates.pdf

H/T:  Advisor Perspectives

Dividend Payers In S&P 500 Index Continue To Grow

Howard Silverblatt, Senior Index Analyst for S&P Dow Jones Indices, recently noted the number of dividend payers in the S&P 500 Index has grown to 402 companies. This number reaches a level last seen in 1999. For 2012, thirteen companies have initiated dividend payments to date.

From The Blog of HORAN Capital Advisors

According to Silverblatt the dollar dividend payment for S&P 500 companies is up 14.7% so far this year. Additionally, he notes, "We expect a record $275 billion in S&P 500 dividends for 2012, up from $241 billion in 2010. The former record was $248 billion in 2008." Lastly, S&P notes, "since 1926, reinvested dividends have accounted for about 41% of the total return of the S&P 500 Index." Certainly, dividends are an important factor for investors to consider when evaluating investment choices.

With the approaching fiscal cliff at the end of the year, which includes the expiration of the current tax policy put in place during the Bush administration, companies may begin paying special dividends prior to year end. The reason for this is the fact the tax rate on dividends is scheduled to increase from 15% to a rate equal to a tax payers ordinary income tax rate.

Trahan: Equity Markets Mid-Way Through Melt Up

Francois Trahan recently spoke with Consuelo Mack on WealthTrack and stated his belief the equity market is mid-way through a melt up. He believes this could last through the end of the year and possibly into the first quarter of 2013. He believes cyclically oriented stocks like industrials and materials, as well as higher beta equities, will be the better investments during this melt up. He believes the S&P 500 Index could reach a high of 1,550. He does believe the market continues to be a secular bear one; however, he does believe we are in the midst of another cyclical bull. He notes in the past 20-years, there were four 50%+ moves in the Japanese market and our low inflation environment is not too different from theirs. In short, he believes buy and hold is dead for the foreseeable future.

From a fundamental perspective he notes several of the cyclical components of the Index of Leading Economic Indicators have turned higher: interest rate spread, average weekly manufacturing hours, and manufacturers’ new orders for consumer goods and materials. Housing continues to improve as housing affordability is at a record high. Also, investors will be drawn out of fixed investments as their low sentiment about equities will provide a tailwind for a short term equity melt up. No doubt, investors continue to allocate investment funds to fixed investments as they are in a "risk off" mindset.

Although Trahan does not provide specific stock ideas in the interview, he does state investors should focus their equity investments on dividend paying stocks. Over 60% of S&P 500 companies have a dividend yield greater than the 10-year U.S. Treasury bond.

Investor Cash Sits In Bond Funds?

In spite of the low interest rate environment, investors continue to be attracted to bond funds. As the below chart shows, fixed income mutual funds continue to attract investors' funds. However, this flow of funds into fixed investments is not inhibiting the rise in the U.S. the equity market though.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

 

Given the low level of cash in money market mutual funds as a percentage of all mutual fund assets it may be that investors have parked their cash funds into bond mutual funds. If/when investors do decide to allocate more funds to equities, fixed income investors may be in for a rude awakening. "Buyer beware" for fixed investors seems an appropriate caution in this environment. Historically, strong flows into fixed mutual funds have not coincided with a rise in the equity market. Something appears as though it needs to give.

From The Blog of HORAN Capital Advisors

Individual investor bullish sentiment as reported by the American Association of Individual Investors did see a rise in bullish sentiment this week. Bullish sentiment rose six percentage points to 36.47% versus 30.45% in the prior week. Additionally, the bull/bear spread flipped from a negative 4.48 to a positive 9.12. The six week moving average remains near a low 30, however, the trend is beginning to indicate a turn higher. Are individual investors being coaxed off the sidelines?

From The Blog of HORAN Capital Advisors

Employment Growth Simply Too Low

Friday's employment situation report by the Bureau of Labor Statistics indicated employment grew by 163,000 jobs in July. No matter how one spins this number, the rate of growth is indicative of an economy that is growing too slowly. The seasonal adjustment actually accounted for 377,000 jobs. The magnitude of this adjustment is not uncommon for the month of July though. What will be interesting is the jobs number in September as the seasonal adjustments in the last few months of the year are historically largely negative.

From The Blog of HORAN Capital Advisors

At this rate of growth, it will take more than two years to get to an employment level reached prior to the '08-'09 downturn and this is not accounting for new entrants (college graduates) into the labor force.

From The Blog of HORAN Capital Advisors

The Friday release also noted that July's unemployment rate rose to 8.3% versus 8.2% in the prior month. The U-6 rate, includes marginally attached workers, rose to 15% and the participation rate declined to 63.7% versus 63.8% in June.

From The Blog of HORAN Capital Advisors

A disappointing jobs report no matter how it gets spun.

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.