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

Current Stock Rally Below Average In Magnitude

"With the S&P 500 trading above 2,000 for the first time in history, today's chart provides some perspective to current rally by plotting all major S&P 500 rallies of the last 82 years. With the S&P 500 up 91% since its October 2011 lows (the 2011 correction resulted in a significant 19.4% decline), the current rally is slightly below average in magnitude above average in duration. In fact, of the 23 rallies plotted on today's chart, the current rally would rank 7th in duration."

Notes:
- A major stock market rally has been defined as a S&P 500 gain of 30% or more (following a correction of at least 15%).
- The S&P 500 was not adjusted for inflation or dividends.
- Selected rallies were labeled with the year in which they began.
- There are 252 trading days in a year (100 trading days equal about 4.8 calendar months).

From The Blog of HORAN Capital Advisors

Source: Chart of the Day

Could there be more upside? The Wall Street Journal has an article out today noting, "Stocks have risen in eight of the past 10 Septembers, with the lone outliers coming in 2008 (the worst of the financial crisis) and 2011 (the middle of the European debt crisis and one month after the downgrade of the U.S. credit rating)."

Dividend Payers' Return Lags Non Payers In August

The equal weighted return of the dividend payers in the S&P 500 Index continues to lag the return of the non payers in August. As a consolation though, the payers equal weighted return is ahead of the cap weighted S&P 500 Index on a YTD and 12-month basis.

From The Blog of HORAN Capital Advisors

Source: S&P Dow Jones Indices

This equal weighted outperformance of the non-payers has carried over into the performance of Guggenheim's equal weighted S&P 500 Index (RSP) versus the cap weighted S&P Index as noted in the below chart. A number of the larger cap dividend payers have struggled on a year to date basis with a number falling in the consumer discretionary sector and industrial sector. For example, on a price only basis, Boeing (BA) is down 7.10%, United Technologies (UTX) is down 5.11%, General Electric (GE) down 7.31%, Best Buy (BBY) down 20.04% and Bed Bath & Beyond (BBBY) is down 19.98%.

From The Blog of HORAN Capital Advisors

Disclosure: Family long GE and UTX

Week Ahead Magazine: August 31, 2014

The strong equity returns in the just completed month of August prove historical expectations do not always play out as the data might suggest. As we noted in our post just before August began, Is This The Much Awaited Market Pullback?, the average August return for the past 10 years has been negative.

From The Blog of HORAN Capital Advisors

With the strong August returns several market pundits are reiterating their often repeated call for a major market correction. A correction would not surprise us, but we do not see the 30 - 60% that is predicted by some investment managers. Several article links in this week's magazine provide insight into these repeated correction calls; one by Barry Ritholtz on David Tice's correction call and the other by Larry Swedroe covering John Hussman's bear market point of view.

The coming week is a holiday shortened one with a number of important economic reports. Most watched will be the data surrounding employment. Jobless claims will be reported on Thursday and the employment situation report will be released on Friday. The employment data is getting closer scrutiny as Janet Yellen has noted the labor market is weaker than it should be. Econoday notes, the employment report likely will play a key role in the next round of Fed forecasts for the economy, posted with the September 17 FOMC statement."The key question is when will the Fed begin to raise rates.

Making up for the light article links from last week, the Monday holiday allowed for me to include a few more articles that might be of interest for the coming week. Below is the link for this week's magazine.

• The Week Ahead Magazine: August 31, 2014

Achieving Excess Returns Around FOMC Meetings

David Blitzer, Chairman of the Index Committee for S&P Dow Jones Indices, recently highlighted research results showing excess returns are generated around FOMC meeting dates. The research paper, Stock Returns Over The FOMC Cycle, evaluates the average 5-day return minus the treasury bill rate. The paper shows statistically significant excess returns are generated in the five day period in advance of the FOMC announcement.

From The Blog of HORAN Capital Advisors

Source: Stock Returns Over The FOMC Cycle

The paper notes the FOMC meeting dates are "quite irregular" and "'even' weeks in FOMC cycle time do not line up with other macro releases that would be influencing returns."

Lastly, the paper looks at the unintended (and intended) information release that comes from the Fed. The report notes, "Overall, it is possible that the bi-weekly patterns in average excess stock returns and fed funds futures volatility result from both subtle intentional and unintentional communication coming from the Fed. The precise mechanism remains a central issue for understanding the economics behind our newly documented asset return patterns and an avenue that we (and hopefully others) will explore."

As S&P's David Blitzer notes in his article title, investors look for short term trading gains might consider to "Sell Just Before, Not After, the FOMC Meets."

Week Ahead Magazine: August 24, 2014

This past week saw the S&P 500 Index set a record closing price of 1,992.37 on Thursday. One article in this week's magazine notes the equity market has gone over 1,020 days without a 10% correction. Investors seem content on buying market "dips". This most recent dip saw the market decline 3.94% from its July 24th closing price down to 1,909.57 on August 7th. The "V-shaped" recovery from August 7th has seen the market advance 4.3% to Friday's close.

From The Blog of HORAN Capital Advisors

The only major U.S. index that remains negative for the year is the small cap Russell 2000 Index which is down .3%. The leader is the Nasdaq composite index which is up 8.7% followed by the S&P 500 Index, up 7.6%. The Dow Jones Industrial Average remains the laggard and is up 2.6% on the year.

Much of the focus this past week was on Janet Yellen's Jackson Hole presentation. The comments had little market impact with treasury yields rising just slightly across most of the interest rate curve. Most of the economic news last week was fairly positive. As we noted in our earlier post today, manufacturing, leading indicator data and jobs data seem to be supportive of a positive economic climate looking out to year end. From an international perspective, economic data remains mixed and saw weakening in most area's Purchasing Managers Indices.

A number of economic data releases are scheduled to be reported this week. Some of the potential market moving reports are:

• New home sales (M)
• Durable Goods Orders (T)
• GDP and jobless claims (Th)
• Personal Income and Outlays (F)

The magazine as well as blog posting has been lighter this week as we were visiting out of town clients during the first half of the week. Below is the link to this week's magazine.

• The Week Ahead Magazine: August 24, 2014

Fundamentals Creating A Positive Environment For Equity Markets In Second Half Of Year

Almost two weeks ago we noted the S&P 500 Index appeared to look more attractive from a technical perspective. Since the market reached a near term low of 1,909.57 on August 7th, the S&P 500 Index has rallied 4.13% through Friday to close at 1,988.40. In addition to a positive technical perspective at that time, recent economic and company reports indicate potential strength ahead. In looking at several economic factors, last week's report on The Conference Board's Leading Economic Index showed an increase of .9% in July, which followed a .6% increase in both May and June. On August 15th the Federal Reserve reported the sixth straight monthly increase in industrial production with July's increase of .4%.

From The Blog of HORAN Capital Advisors

The continued improvement in the LEI Index and industrial production is showing up in the ISM non-manufacturing survey, specifically in new orders. The report noted,

"the New Orders Index registered 64.9 percent, 3.7 percentage points higher than the reading of 61.2 percent registered in June. This represents the highest reading for the New Orders Index since August 2005 when it registered 65.3 percent."

The early August report notes respondents indicating strength in the second half of this year as well. A couple of direct highlights from the report:

• "Conditions are improving." (Construction)

• "Slight improvement in the economy, but still experiencing delays in client project start-ups. Expecting some improvement in 4th quarter." (Professional, Scientific & Technical Services)

• "Second half of the year is looking promising for increased orders versus last year." (Information)

• "Business is still very good. Expecting continued growth in the 2nd half of the year." (Retail Trade)

• "Business has been strong this summer after a late start due to the poor spring weather." (Wholesale Trade)

From The Blog of HORAN Capital Advisors

Lastly, with the second quarter 2014 earnings season essentially at an end with 486 companies having reported, the year over year growth rate for earnings in the quarter came in at 10.2% (excluding Citigroup (C)). It is not anticipated the remaining companies yet to report will change the 10+% growth rate. Thomson Reuters notes, if this growth rate holds, it will represent the second highest quarterly growth rate since the fourth quarter of 2011. The revenue growth rate recorded so far in Q2 is 4.6% with the health care sector leading the way with revenue growth of 12.2% in Q2.

Investors and strategist may be viewing the coming end of QE as a brick wall for the economy. However, current economic reports and company reports are suggesting the economy may be able to function without outside stimulus. I have not touched on the improvement in the job market, but this is another positive as well. I will highlight some of these items in our Week Ahead Magazine post, but several market moving reports in the coming week include the second reading on Q2 GDP and jobless claims on Thursday.

Disclosure: No position in C

Week Ahead Magazine For August 17, 2014

After the market's close this past Tuesday we wrote a post discussing how the market technicals had turned more positive and the market did not disappoint. For this past week the equity market did turn higher with the major U.S. indices posting weekly gains. The standout was the Nasdaq Composite Index returning 2.2% and now up 6.9% on the year. The much watched small cap index, the Russell 2000, managed to generate a gain of .9%; however, the index remains down 1.9% year to date. Last week's news was dominated by geopolitical issues, e.g., the Ukraine/Russia conflict. The issues taking place on the European continent seem to be impacting economic and consumer sentiment in the Euro Zone. As Econoday noted in their weekly recap,

"Numbers for second quarter GDP for France, Germany, and the EU fell below expectations—including a negative number for German GDP, largely damped by Ukraine concern. It was more current news that lifted stocks after President Vladimir Putin said Russia will work to stop the conflict in eastern Ukraine. Equities were mixed Friday on a report that Ukraine government forces attacked an armed convoy from Russia—allegedly carrying humanitarian aid."

The highlight for this week may be commentary from the Fed Symposium at Jackson Hole. This event has taken place since 1978 and this year's topic will be "Re-Evaluating Labor Market Dynamics." In the interim, potential market moving economic reports for the coming week include:

• Consumer Price Index and Housing Starts (M)
• FOMC Minutes (W)
• Jobless Claims, Philadelphia Fed Survey and Existing Homes Sales (Th)

Articles of interest can be found in this week's magazine with the link provided below.

• The Week Ahead Magazine: August 17, 2014

Market Technicals Turn More Positive

Short term technicals for the S&P 500 Index have turned more positive after the market's recent pullback. As the below chart shows, the 100 day moving average has served as important support for the market over the past year and a half. Each time the market has experienced a pullback, the market has managed to bounce off of the 100 day moving average line. Additionally, the full stochastic oscillator has begun to turn higher from an oversold level. The vertical dotted lines on the chart display areas where this indicator began to turn higher and where the S&P 500 Index bounced off of its 100 day moving average. The money flow index (MFI) declined to a level near where an oversold market would be indicated (< 20) and may be bottoming and attempting to turn higher. The MFI incorporates volume and is another version of the relative strength index. With volume included in the calculation, some believe volume leads price; therefore, increasing volume at a time the market is turning higher can be indicative of a market move higher.

From The Blog of HORAN Capital Advisors

From a fundamental perspective, earnings in the second quarter are expected to increase by 8.2%. When looking at earnings that exclude Citigroup's (C) earnings report, Q2 earnings are expected to be higher by 10%. We have not seen double digit earnings growth (ex Citigroup) since 2011. Third quarter earnings growth expectations equal 9.3% and fourth quarter growth expectations equal 12.2%. With strong earnings reports from companies and a market that seems to have worked off oversold conditions, higher prices may be realized if not just in the second half of August, but through the balance of the year. Of course, geopolitical issues are a wild card as well as the mid term election in the U.S. in November.

Disclosure: No position in C

Week Ahead Magazine For August 10, 2014

Last week saw the market's trading action gravitate from positive to negative during the week until Friday. The chart to the right shows the daily changes in various market indices with Friday's sharp bounce back. A question for this week will be whether last Friday's trading bounce signals a bottom in the market's recent decline.

Today pre-market futures are indicating a positive start to the trading week. This comes on the heals of positive market performance in global markets on Monday. One article link in the Week Ahead Magazine covers some technical data that is suggestive of a potential market bottom. Additionally, another article notes the decline in investor bullish sentiment, as well as investors continued appetite for bonds. Below is the link to this week's magazine.

• The Week Ahead Magazine: August 10, 2014

Bond Funds Continue To See Inflows

Last week's mostly negative market, until the sharp recovery on Friday, continues to negatively influence investor's market sentiment. Last week's American Association of Individual Investors reported bullish investor sentiment fell slightly to 30.9%. This bullishness level is nearly nine percentage points below the long term average of 39%.

From The Blog of HORAN Capital Advisors

Source: AAII

An interesting factor reported in the Sentiment Survey was the 7.1% increase in bearish sentiment to 38.2%. Much of the recent commentary seems centered around the fact the market (S&P 500 Index) has not experienced a 10%+ market correction in over 30 months. Factor in the number of geopolitical issues around the globe and the Fed's reduction of QE, it is no wonder investors have a less than favorable view of the market.

Fund flow data seems to be supportive of the fact investors are not overly bullish. The below chart shows fund flow data through June. Every month except for January of this year has seen positive investor flows into bond and income funds. June of this year witnessed the first outflow from equity mutual funds in over a year. This equity fund outflow continued in July as noted in the table following the monthly fund flow chart below.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Source: Investment Company Institute

In spite of what seems like a near uninterrupted advance in the equity markets since the end of of the Great Recession, fund flow data does not suggest investors have reallocated out of bonds into stocks in any significant way. In looking at the below chart, it seems apparent the cumulative flow of funds into bond and income funds still far out weighs any recent positive flows into equity funds. As noted earlier, and this can be seen on the below chart, positive flows have returned to bond funds this year.

From The Blog of HORAN Capital Advisors

Generally, market tops do not get realized until a capitulation, "all-in" type positive inflow into stocks occurs.

Currency Adjusted Returns Matter When Investing In Foreign Markets

Almost a year and a half ago the Bank of Japan stated it would embark on a massive stimulus plan, i.e., quantitative easing, that would amount to the equivalent of $107 billion US dollars. Many strategists have taken a positive view of this effort by Japan to stimulate the country's economy. The near term, immediate impact to Japan's stock market at that time, the Nikkei 225 Index, was a dramatic move to the upside. As the below chart shows (two year time frame), the Nikkei was up over 80% from August 2012 through May of 2013 and the S&P 500 Index was up only 20%. However, when the Nikkei returns are converted back to the US Dollar, the Nikkei returns equal about 35%.

From The Blog of HORAN Capital Advisors

Fast forward to the end of 2013 from August 2013 and the Nikkei continued to outperform the S&P 500 Index; however, when converting the Nikkei returns to US Dollars (blue line in the below chart), the Nikkei has underperformed.

From The Blog of HORAN Capital Advisors

Many investors gain exposure to foreign markets via mutual funds or ETFs. For investors then, it is important to understand the currency hedging strategies being employed within a particular fund. If a fund had not been hedging its currency exposure in the Nikkei for a US domiciled investor, returns would have been significantly impaired.

The currency hedging issue has always been important, maybe more so today given central bank interventions. The central bank stimulus programs have resulted in weakening the currency of the central bank's country. In the case of Japan, the weaker YEN (stronger US Dollar) has negatively impacted US Dollar returns.

Also, recent media reports are touting the strong returns in "frontier" markets. For investors, they need to analyze the currency hedging strategy in the fund(s) they intend to invest in. A strong dollar relative to other currencies can significantly reduce any return advantage these non-U.S. markets may generate in their respective home country currency.

Why To Invest In Stocks

I wrote an article this past weekend that provided a link to an interview with Jason Trennert conduct by Consuelo Mack of WealthTrack. The theme of the interview and the post is the belief there currently is no alternative for investors other than stocks. My article was republished on Seeking Alpha and a reader responded with several comments and questions. I responded to his questions and the reader thought the response was worthy of an article of its own. Below are the reader's questions/comments and my response.

1. Why is the shrinking number of listed companies important?
2. The total market cap is at an all-time high, and the ratio of total market cap to GDP is near an all time high.
3. Is there any rigorous study that shows that currently low interest rates have a strong correlation with 'future' stock market returns?

The shrinking number of listed companies is important from the standpoint of supply and demand. If demand for stocks remains the same and the supply of available stock declines, then prices will gravitate higher, all else being equal. In the video referenced in my earlier article, I believe Jason Trennert provides pretty good commentary behind the decline in company stock listings. Certainly some companies have gone out of business since the dot.com bust. However, Trennert notes an increasing number of companies lack the desire to go public due to the regulatory and legal cost. Some of what is occurring is companies will sell themselves to private equity firms.

From The Blog of HORAN Capital Advisors

Additionally, the current environment has witnessed a pick up in M&A activity and this was cited in a recent report by Jeremy Grantham of GMO as well. The M&A activity results in reducing stock supply. Increased M&A historically is an early, late business cycle activity. Grantham and others believe we are in the middle innings of M&A in this cycle. When public companies deploy excess cash in an acquisition, the balance sheet cash that is earning virtually zero percent interest then results in the acquisition being accretive to corporate earnings.

Regarding interest rate movement and stock prices when rates rise from a low level. JP Morgan has an interesting chart showing when rates rise from a low level, below 5%, stocks have a positive correlation to the direction of the rate move. Intuitively, this might make sense in that the Fed is simply moving rates back to a neutral level in order to have fire power in the event it is needed. When rates are increased at levels above 5%, this is generally a sign the Fed is attempting to slow down the economy. Maybe inflation is beginning to become an issue, tight capacity, higher wage growth, etc. In this situation, the rate rise, when above 5%, likely would result in slowing economic activity and as such slowing earnings growth which then leads to lower stock prices.

From The Blog of HORAN Capital Advisors

Source: JP Morgan GTM

 

Lastly, regarding equity values and GDP, Scott Grannis of the Calafia Beach Pundit website has a good article discussing this valuation measure. The article is a worthwhile read. In short he notes valuations by this measure are at levels similar to the early 1960s. He notes in the article the early 1960s was an environment "when inflation was low and stable and U.S. interest rates were low and stable, much as they are today." Below is the valuation chart he included in the article.

From The Blog of HORAN Capital Advisors

Source: Calafia Beach Pundit

From a contrarian standpoint, I must say the amount of bearish commentary mentioned over the past several weeks seems to be dominating the headlines. The below chart highlights the increase in Google (GOOGL) search activity for the phrase " stock market correction." Historically, market corrections do not occur when everyone expects them. Having said this, this is a seasonally weak period for equities.

From The Blog of HORAN Capital Advisors

Source: Google Trends

Disclosure: Long GOOGL and GOOG

Massive Bearish Put Volume On Friday May Have Been An Error

Over the weekend we noted the big spike in the put/call ratio to 1.04. Generally, when the put/call ratio exceeds 1.0, from a contrarian perspective, this overly bearish activity can be a positive for stock prices. Was the increased volume an error?

Reuters is reporting the trades could be an error. In the article lead in they note, "A barrage of bearish options contracts costing an estimated $8 million and set to expire worthless in a few hours were purchased across multiple stocks Friday afternoon in a move that traders said made no sense." If these trades are an error, maybe bearish sentiment is not has elevated as the data suggested.

Dividend Payers Underperformed In July

Much is made by some investment managers that dividend payers hold up well in market downturns. Generally, we would agree that is the case; however, this performance advantage does not always bear out and one must look at the underlying cash flow of individual companies. A case in point is the performance of the payers in July.

As the below table shows the average performance of the payers underperformed the non-payers by almost two full percentage points. On a year to date basis the average return of the payers is also lagging the return for the non-payers. As the below performance table shows, most S&P 500 companies do pay a dividend. The difficulty with the safety trade in July was the fact some of the defensive sectors underperformed the overall S&P 500 Index. The staples sector is one of those defensive sectors and the relative performance versus the S&P 500 Index is noted below as well. In that chart, if the line is declining, the noted sector is underperforming the broader S&P 500 Index.

From The Blog of HORAN Capital Advisors

Source: Dow Jones Indices

From The Blog of HORAN Capital Advisors

One sector that performed well versus the overall S&P 500 Index was technology. At HORAN we do believe this sector continues to offer opportunities for investors.

From The Blog of HORAN Capital Advisors

Week Ahead Magazine: August 3, 2014

With July in the books, investors experienced the negatives of what tends to be a weak seasonal period for the equity markets. The worst performing segment of the U.S. market continued to be the pullback in small company stocks as represented by the Russell 2000 index. Small caps declined 7.3% in July while the larger cap stocks represented by the S&P 500 Index fell 2.8%. Small caps are now down 4.2% year to date while the S&P 500 Index remains higher by 4.2%.

For the most part economic news this past week was positive. Probably the most positive report was the first read on second quarter real GDP that was reported at 4.0%. For many, including us at HORAN Capital Advisors, there seems to have been a bounce back in economic activity from the weakness experienced in the first quarter due to the extreme cold weather conditions across the U.S. at that time. We do expect, however, this snap back was not significant enough to expect this level of growth through the balance of the year. One article in our magazine covers some of the underlying concerns with the recent GDP report.

Lastly, economic reports for the coming week will be relatively light. Additionally, the pace of earnings reports slows with a number of the reports coming from companies less optimistic about growth prospects. As we have noted in several reports on our blog this week, much technical damage was done to the market this past week. The magazine highlights several indicators that indicate the market is at least oversold on a short term basis which could result in a market bounce this week. The key will be whether or not the bounce can carry forward to a continuation of this bull market.

• The Week Ahead Magazine: August 3, 2014

No Alternative Other Than Stocks

Consuelo Mack of WealthTrack recently interviewed Jason Trennert, Managing Partner and Chief Investment Strategist of Strategas Research Partners. As WealthTrack notes, "Trennert is widely followed by institutional investors in the money management and hedge fund world, and is identified as one of “Wall Street’s Best Minds” by Barron’s."

In the interview, Trennert believes several factors are leaving investors with no investment alternatives other than stocks. Two reasons he cites are one, financial repression, where governments in developed economies institute policies that keep real interest rates at low or negative levels, and two, the reduced supply of publicly traded stocks. This reduced stock supply is evident in one of the charts Jason displayed during his Consuelo Mack interview.

From The Blog of HORAN Capital Advisors

Source: WealthTrack

The full interview is a worthwhile one for investors to spend time watching. The full interview is accessible below.

Equity Put/Call Ratio Spikes To Above 1.0

In our earlier post today we noted the potential oversold conditions in the equity markets. When reviewing other technical data this morning, I was surprised to see the large jump in the CBOE equity put/call ratio on Friday which put the ratio above 1.0. We have noted in prior posts over the years that this sentiment ratio is most predictive of future market direction when the ratio is at extreme levels. In short,

The equity P/C ratio tends to measure the sentiment of the individual investor by dividing put volume by call volume. At the extremes, this particular measure is a contrarian one; hence, P/C ratios above 1.0 signal overly bearish sentiment from the individual investor. This indicator's average over the last 5-years is approximately .625 indicating the individual investor has been generally mostly bullish and more active on the call volume side.

From The Blog of HORAN Capital Advisors

Market Looking Oversold

Both the New York Stock Exchange Index (NYA) and the S&P 500 Index (SPX) are down from their recent highs 3.7% and 3.2%, respectively. Although the magnitude of the declines is not large, the indices are looking oversold. The relative strength index, the MACD indicator and the stochastic indicator are indicating oversold levels as well. It should be noted that the MACD is less useful as an oversold market indicator as it is unbounded. The MACD is most useful in determining market turning points when crossovers occur with the MACD line (green line in bottom pane) and the red signal line.

From The Blog of HORAN Capital Advisors

In looking at the percentage of NYSE stocks trading above their 50 and 150 day moving averages, these two measures are near levels where past market sell offs have bottomed. Certainly, these percentages can go lower.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors