Week Ahead Magazine: A Central Bank Throws In The Towel

Investors paying attention to the market last week witnessed something they may not see for the balance of their lives. The Swiss National Bank's surprise announcement that it would no longer try to maintain the Swiss Franc's currency peg resulted in the Franc/Euro exchange rate falling nearly 30% in a single day. In actuality, the collapse occurred within seconds of the announcement. This type of currency move speaks volumes about the unintended consequences of the quantitative easing programs being pursued by central banks around the world. Evercore ISI notes there have been forty easing moves by central banks around the globe in just the last three months. Investor should remain vigilant as they pursue investment opportunities in 2015.

From The Blog of HORAN Capital Advisors

This week's Week Ahead magazine contains a number of links to articles discussing the implications of the Swiss National Bank's policy change. Additionally, a number of articles contain updated commentary about the state of the energy markets. Maybe $50/bbl is the new near term top in energy prices with further downside ahead. At the end of the day, these lower energy prices should translate to more of an economic benefit to consumers than the negative implications from reduced earnings from the energy sector. Below is the link to this week's magazine.

• Week Ahead Magazine:  A Central Bank Throws In The Towel

Hyman & Kim: U.S. Pulling Global Economies

One comment mentioned of late is the U.S. economy may be decoupling from the rest of the world economies. In Part 2 of Ed Hyman's and John Kim's interview (Part I of Interview) with Consuelo Mack on Wealthtrack, both Hyman and Kim believe it is not possible for the U.S. economy to decouple from the rest of the world at this point in time. The globalization of trade and manufacturing has created an interconnectedness that will be difficult to break. Both Hyman and Kim believe, however, that the economic strength in the U.S. is pulling along other economies around the world.

A large part of the interview is focused on markets outside the U.S. However, one investment area both expressed concern about was the liquidity of the bond market. The Volker Rule and Dodd Frank legislation have created a potential crisis in the bond market. These rules have reduced bond inventory of the Wall Street banks from $250 billion to $50 billion today. At the same time, retail investors have increased their bond exposure from $1.7 trillion to $3.5 trillion. If a crisis were to occur in fixed income, Wall Street does not have the ability to clear this level of trading. On October 15th the treasury bond market had what some traders call a flash crash. Themis Trading noted in an article at that time,

"The bond market appears to have fundamentally changed and no longer seems to have the built-in liquidity shock absorbers provided by traditional dealers. Some will say that Dodd-Frank caused this since dealers can no longer hold as much inventory. Some will say that this is just the natural evolution of electronic trading. But something is wrong when the safest bonds in the world experience such a rapid price move in such a short time period."

The below video also contains a good discussion on asset class allocations that readers/investors may find of interest.

Shale Oil And Gas Production Projected To Increase In February

The battle between OPEC and shale fracking producers has pushed the price of oil down to levels unthinkable just a year ago. Both parties seem unwilling to reduce production to levels that would stem the decline in oil prices. This lower price level is certainly placing financial stress on a number of drillers and leveraged fracking companies as noted in the article, Money Dries Up for Oil and Gas, Layoffs Spread, Write-Offs Start.

From The Blog of HORAN Capital Advisors

In spite of the apparent difficulties facing drillers and shale fracking companies, production growth continues to be projected for oil and gas out of the shale regions in the U.S.

From The Blog of HORAN Capital Advisors

Source: U.S. Energy Information Administration

From The Blog of HORAN Capital Advisors

Source: U.S. Energy Information Administration

The U.S. Energy Information Administration released its weekly petroleum report late last week and natural gas inventories declined 236 bcf.This draw-down still left natural gas storage levels higher than at the same time last year, 2,853 bcf versus 2,571 bcf last year.

The well known headwinds facing the various companies in the energy sector have yet to result in a reduction in oil and natural gas supplies. With the new layoff announcements, capital expenditure cuts and financing difficulties by some energy companies, a reduction in supply may ultimately be realized over the next several quarters. The market is anticipating some stabilization in crude prices as noted by the short term price chart for crude oil. However, this may be premature given the continued growth in oil and natural gas production levels as noted earlier. The end result is a continued increase in supply as reduced demand seems to be an issue as well. In the weekly petroleum report, the EIA noted, "U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 5.4 million barrels from the previous week. At 387.8 million barrels, U.S. crude oil inventories are at the highest level for this time of year in at least the last 80 years. [emphasis added]"

From The Blog of HORAN Capital Advisors

Ed Hyman: Bull Market In Early Stage

Ed Hyman, Chairman of Evercore ISI, has been ranked the #1 economist by Institutional Investor for an unprecedented 35 consecutive years. In a recent interview he participated in with Conseulo Mack of WealthTrack, Ed Hyman provides his outlook for the economy and markets in 2015. In one portion of the interview below, he believes the economy and equity markets are in their early stages of recovery. One fact he noted is many of the cyclical components of the economy are where they would be at the beginning of an economy coming out of recession. The fact the economic contraction resulting from the financial crisis was so deep, the recovery to date simply gets the economy back to its more typical early stage.

A caution he was certain to note centers around the consequences that historically have occurred with a contraction in oil prices. He points out that prior oil price contractions, like currently being experienced, have generally been associated with some type of financial shock in some segment of the market. In 1986 when Brent Crude fell from $30/bbl to $10/bbl, although GDP growth was 3% and the market returned 15%, we did have the S&L crisis. With the oil price decline in 1996 to 1998 the market had to navigate the fall out of Long Term Capital Management, the Asian financial crisis in 1997 and the Russian financial crisis in 1998. In spite of these crises, in 1997 the S&P 500 Index was up over 30% and in 1998 the Index was up 27%. Knowing where the next crisis will develop is most certainly a search for a needle in a haystack. Diversifying one's investment portfolio should insulate one from a potential shock like experienced in the late 1980s and  late 1990s. Below is PArt One of the WealthTrack interview.

Dividend Payers Underperformed Non Payers In 2014 And Equal Weighted Risk

The chase for yield in 2014 did not lead to the dividend payers in the S&P 500 Index to outperform the non-payers. As the below table shows, the average return of the payers, 14.99%, fell just short of the average return of the non-payers that generated a return of 15.44%. The average return for both categories though did beat the cap weighted return of the overall S&P 500 Index.

From The Blog of HORAN Capital Advisors

Source: S&P Dow Jones Indices

Jim Paulsen, Ph.D., Chief Investment Strategist at Wells Capital Management, recently wrote a research article on valuation of the S&P 500 Index. In his report, Median NYSE Price/Earnings Multiple at Post-War RECORD, Paulsen notes the median stock in the index trades at a record high valuation at approximately 20 times earnings. The report notes historically, when the market traded at high valuations, investors could find certain sectors not trading at high valuations. An example noted in the report,

"The 2000 stock market was characterized by a significant overvaluation among the fifth to 20th P/E percentiles while valuations in most of the rest of the market were either average or below average. Today, the entire stock market (low P/E stocks to high P/E stocks) appears highly valued relative to history. Similarly, Chart 8 [in the report] illustrates that today’s valuation profile is also much more broadly extended than it was at the top of the 1970’s Nifty Fifty era."

According to Paulsen, an implication of this high median valuation could be cap weighted indexing for the U.S. market will generate better returns than an equal weighted approach. Additionally, international market valuations suggest opportunities may exist in those markets vis-à-vis the U.S. Several of his comments in the report around this topic,

• "First, the valuations of U.S. stocks are much higher than widely perceived or as suggested by the valuation of the popular S&P 500 Index. Moreover, today’s valuation extreme is not limited only to a subset of stock market sectors but rather is very widespread whereby nearly all P/E multiple percentiles are at or close to post-war records."

• "Finally, the current valuation extreme is not the result of poor performance from a single valuation metric. U.S. stocks are broadly and richly priced compared to earnings, cash flows, and book values. Second, because valuation dispersion is relatively low today, there are not many areas to hide from overvaluation. In 1973 or 2000, investors could reduce extraordinary valuation risk by simply diversifying away from the Nifty Fifty or new era tech stocks. Today, because values are both high and tight, lessening valuation risk may not be possible except by allocating away from U.S. stocks."

• "Today, even though a larger portion of the overall stock market is aggressively priced, it has not garnered nearly as much attention. A concentrated valuation extreme tends to loudly announce itself whereas a broad-based valuation extreme seems more stealth and, therefore, perhaps more dangerous."

Week Ahead Magazine: A Week Of Outlooks For 2015

Much of the focus in this week's magazine are links to various commentaries on the market and economic outlook for 2015. As one considers investment changes, the following quote might be appropriate in guiding potential changes.

“The riskiest moment is when you’re right. That’s when you’re in the most trouble, because you tend to overstay the good decisions. So, in many ways, it’s better not to be so right. That’s what diversification is for. It’s an explicit recognition of ignorance. And I view diversification not only as a survival strategy but as an aggressive strategy, because the next windfall might come from a surprising place.” Peter Bernstein

h/t: A Wealth of Common Sense

Below are a few links not contained in the magazine that readers may find of interest as well.

• Nuveen Investments 2015 Outlook:  World Economies Rebuild as U.S. Growth Strengthens
• Blackrock: Investment Directions 2015 Outlook
• BofA Merrill Lynch: Bull Market Slows to a Jog in 2015
• Goldman Sachs: Outlook 2015
• Charles Schwab: 2015 Market Outlook
• Fidelity Investments 2015 Stock Outlook: Cautious Optimism

Following is the link to this week's magazine.

• Week Ahead Magazine: A Week Of Outlooks For 2015

Dividend Growth Equities Outperform During Increasing Interest Rate Periods

At the end of 2013 most if not all strategists expected interest rates to rise with the anticipated end of quantitative easing. However, the market proved the consensus point of view wrong. As the below chart shows, the high rate on the 10-year treasury occurred at the beginning of 2014 at just over a 3% yield. Throughout the year the interest rate trend was lower culminating in a spike lower to 1.87% in mid October.

From The Blog of HORAN Capital Advisors

The consensus view for interest rates in 2015 is the same as 2014, that is, rates will end the year higher. If this higher rate cycle is realized, investors realize the impact on bond prices is a negative one. For stocks though, a higher Fed rate cycle historically is not a negative for equities. As the below chart details, during periods of rising interest rates, dividend growth stocks have generated higher, and positive, returns with less volatility.

From The Blog of HORAN Capital Advisors

Source: Blackrock (pdf)

Investors should keep in mind dividend paying stocks historically dip lower an average of 9% during the first 3-4 months of the increasing rate cycle.

Finally, in an early 2014 article in the Wall Street Journal, the author looked at average calendar year returns going back to 1963. The table included in the article(below) notes large company stocks generate near double digit returns during rising rate periods with small caps generating mid teens returns.

From The Blog of HORAN Capital Advisors

Source: Wall Street Journal

If rates do rise in 2015, stocks may face an initial downward shock; however, over the entire rate cycle, stocks can be a positive contributor to one's portfolio performance.

Better Investing Members Buy A Few Underperforming Stocks

Around this same time last year I provided an update of the stocks most favored by members of the Better Investing community. The list is an informal sampling self reported by members as of January 3, 2015. Several of the active "buy" stocks on the list a year ago now fall into the active "sell" category like 3D Systems (DDD) and Qualcomm (QCOM). The frequently updated list can be accessed at this link.

From The Blog of HORAN Capital Advisors

Full View

A Market Needing To Resolve Divergences In 2015

As 2014 has come to a close, investors have turned their attention to 2015 and looking for clues as to what the market and economy have in store for the new year. Below are divergences that unfolded in 2014 which raises the question of how they will be resolved this year. The resolution of these divergences will likely have implications on the performance of an investor portfolios this year.

Oil Prices

Knowing the stock market is not the economy and vice versa, determining factors contributing to the significant decline in oil prices is important. Certainly, increased supply is influencing the decline in crude prices. Equally though, as we have noted in several earlier articles, we believe lack of demand is also a contributing factor. The importance of the reduced demand leads strategist to raise the question of whether the global economy is entering a slowdown. To date, the U.S. seems to have shaken off the potentially negative impact of slowing economies outside its borders. Given the interconnectedness of the economic world today though, can the U.S. continue on its growth path while many other economies in the developed and emerging world struggle with growth? As the below chart indicates, historically, falling oil prices have been associated with slowing global GDP.

From The Blog of HORAN Capital Advisors

Aubrey Basdeo, Managing Director at Blackrock, noted the potential negative impact of an extended run of low oil prices in an article late last year titled, Free Fallin'. The article's conclusion,

Wherever the price ends up, it’s likely it’ll stay there for a while. We don’t see demand increasing, especially with China cooling off. In the short-term that could be good news for our economy — lower gas prices mean people have more money to spend — but it remains to be seen just how our country will be impacted by a sub-$60 oil price. The longer it stays low, though, the more difficult things could get.

Highlighted in the Felder reference below was a comment by Howard Marks' in a recent investor letter,

"It’s historically unprecedented for the energy sector to witness this type of market downturn while the rest of the economy is operating normally. Like in 2002, we could see a scenario where the effects of this sector dislocation spread wider in a general ‘contagion.'”

High Yield Bonds: Reduced Investor Risk Appetite

The performance of high yield bonds has an above average positive correlation to the performance of equities. In short, as the economy grows, companies tend to experience better earnings growth. This improved earnings outlook generally leads to improved equity returns. Broadly, as companies generate better earnings growth, highly leveraged ones tend to experience an improved outlook as well. This in turn reduces the risk of default with highly leveraged companies. Consequently, high yield bond prices are bid up as investors are attracted to the higher yields provided by high yield debt in an environment where default risk seems lessened.

A recent article by Jesse Felder of The Felder Report took an in depth look at the long term and short term price movements of high yield (HYG) relative to a riskless 3-7 year Treasury ETF (IEI) and the S&P 500 Index. As the first chart below shows, the high yield relative to treasury bond investment tracks closely with the S&P 500 Index.

From The Blog of HORAN Capital Advisors

Felder notes in his article,

Clearly, the chart above demonstrates that the strength in junk risk appetites led stocks off the lows back in 2009. Over the past summer, however, junk bonds started to lag stocks for the first time since the bull began (or lead lower, depending on your perspective). Since then the divergence has only gotten wider with each subsequent new high in the stock market [as seen in the below chart]:

From The Blog of HORAN Capital Advisors

Large Caps Versus Small Caps And The Dollar

The one asset allocation decision investors and advisers needed to get right in 2014 was to overweight U.S. equities, large caps more specifically, versus broad international. As can be seen in the two charts below,  U.S. large cap stocks had a decisive performance edge versus developed international (EFA), emerging markets (EEM) and small cap equities (IWM).

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

With economies currently weaker outside the U.S. and interest rates lower in many European countries, foreign investors have allocated investment dollars to the U.S. This flow of funds into the U.S. has contributed to downward pressure on U.S. interest rates as well as continued upward pressure on the U.S. Dollar.

From The Blog of HORAN Capital Advisors

The top chart above shows a longer view of the trade weighted US Dollar and its recent strength, although strong shorter term, the strength does not look exhausted when viewing the longer term chart. The implication of a stronger dollar has to do with the potential earnings headwind for large multinational companies. In a slow growing economy, the currency headwind can take a bite out of corporate profit growth. If this occurs, small and mid size companies are less exposed to exchange rates as business for these companies is mostly generated domestically.

Lastly, the U.S. equity markets opened higher on the first trading day of the new year, but quickly turned lower near the time the ISM Manufacturing Index was reported. The manufacturing index was reported at 55.5 which was below consensus expectations of 57.5. This was the slowest rate of monthly growth in six months. Econoday noted, "growth in new orders slowed substantially, to 57.3 from November's exceptionally strong 66.0, while backlog accumulation also slowed, to 52.5 from 55.0. Production slowed to 58.8 vs 64.4....The abundant run of manufacturing reports point to year-end slowing in a sector which is oscillating going into the New Year."

The above highlights are just a few divergent factors that have developed recently. From a positive perspective, the equity markets have a tendency to climb the proverbial "wall of worry." We will cover more of our thoughts on these topics in our upcoming year end Investor Letter. 

Pre-Election Year Equity Return Favors The Bulls

In our Monday post one bullet point noted the favorable equity market returns achieved in a pre-election year. Today, Chart of the Day sent out a chart which graphically shows favorable returns that historically have been generated during the first seven months of pre-election years.

From The Blog of HORAN Capital Advisors

Source: Chart of the Day

Their commentary notes,

"Since 1900, the stock market has tended to outperform during the first seven months of the average pre-election year. For the remainder of the year, pre-election performance has tended to be choppy and slightly subpar. In the end, however, the stock market has tended to outperform during the entirety of the pre-election year. One theory to support this behavior is that the party in power will make difficult economic decisions in the early years of a presidential cycle and then do everything within its power to stimulate the economy during the latter years in order to increase the odds of re-election."

As the the calendar begins a new trading year on Friday, commentary will likely shift to other seasonal market indicators. One such indicator notes that so goes the first five trading days in January so goes the rest of the year. Unless the market experiences a major catastrophe today, this indicator gave investors a false signal in 2014. According to the Stock Trader's Almanac, the first five trading days of 2014 had the S&P 500 Index down .6% while the S&P is up mid teens percent as I write. In spite of this fact, the Almanac notes, "the last 41 up Five Days were followed by full-year gains 35 times for an 85% accuracy ratio and a 14.0% average gain in all 41 years."

The past two years have been rewarding ones for investors. Seasonality alone will not trump fundamentals and the turmoil in the energy market may be signaling broader issues with the underlying economy. We plan on touching on this issue in our upcoming quarterly Investor Letter and additional posts in January.

Week Ahead Magazine: The Last Week Of 2014

The day after Christmas saw the S&P 500 Index hit its 52^nd record close for the year. Of note this past week was the strong GDP report (third estimate) for the third quarter reported at 5%. This was higher than the 4.3% consensus estimate. A potential offset to the strength in the GDP report was the durable goods report for November. The consensus estimate was a 3.1% increase with the actual report showing a decline of .7% . Oil prices continue to be a focus and Aswath Damodaran, Professor of Finance at the Stern School of Business at NYU, wrote an good article about the potential impact to various sectors of the market as a result of the decline in oil prices. A number of the articles in this week's magazine continues to highlight the issues surrounding hte energy sector. As a final note, the Stock Trader's Almanac Blog noted the following about the current market cycle.

• 2015 is a pre-presidential election year, the best year of the 4-year cycle. Since their last loss in 1939, the third year of the cycle is up 16.0% on average for the Dow and 16.3% for the S&P 500. Since 1971 NASDAQ averages a whopping 30.9% in the third year of the 4-year cycle.

• It is also the fifth year of the decade, which is also the best year of the decade with only one loss in the past thirteen decades. Years ending in “5” average 28.3% for the Dow and its predecessors since 1885, with S&P 500 averaging 25.3% since 1935 and NASDAQ averaging 25.6% since 1975.

• We are also now firmly in the sweet spot of the 4-year cycle (midterm Q4 & pre-election Q1-2). These best three quarters of the 4-year cycle have produce averaged gains of 21.5% for the Dow and 22.2% for the S&P 500 since 1950 and 34.1% for NASDAQ since 1974. 

With the market entering what has historically been a strong cycle period, the next magazine will likely focus on forecast for 2015 for what they are worth. Below is the link to this week's magazine.

• The Week Ahead Magazine: The Last Week Of The Year

Strong Rebound In Third Quarter 2014 Buybacks

After the second quarter's significant decline in buyback activity, S&P Dow Jones Indices preliminarily reports S&P 500 companies increased third quarter buybacks by 25%. Buybacks for the third quarter totaled $145.2 billion versus the $116.2 billion reported in the second quarter. Apple (AAPL) holds the top three spots in record quarterly buybacks with the third quarter amounting to $17 billion. This is just short of the record level of $17.97 billion in the first quarter of this year held by Apple.

From The Blog of HORAN Capital Advisors

Source: S&P Dow Jones Indices (.xls)

This level of buyback activity has been a tailwind for earnings per share growth. Howard Silverblatt, Senior Index Analyst for S&P, notes,

• "While third quarter expenditures were up 25%, the number of companies reducing their share count declined 13%. Still, over half of the S&P 500 issues reduced their share count with 20% decreasing them enough to impact their year-over-year EPS by at least 4%."

• "...companies continue to increase their total shareholders’ returns through regular cash dividends, as well as buybacks. Over the year ended September 2014, buyback and dividend expenditures combined reached a new record high of $892.7 billion, with buybacks representing 62.0% of the total."

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

 Silverblatt believes the forth quarter will also be a strong period for buyback activity.

Source:

S&P 500 Q3 2014 Buybacks Increase 25% Over Q2
S&P Dow Jones Indices
By: Howard Silverblatt, Senior Index Analyst
December 23, 2014
http://us.spindices.com/documents/index-news-and-announcements/20141223-sp-500-buybacks-q3-2014.pdf?

Disclosure: Family Long AAPL

Santa Claus Delivers Cheer After Christmas

In spite of the fact the market seems to experience a much awaited 10% correction, the last few weeks of a calendar year are generally positive ones for equity returns. Below is a chart of various indices prepared by Charles Schwab outlining the returns over the last two weeks of the year looking back twenty years. The FTSE 100 Index historically generates the highest return for investors; however, other noted markets have been positive as well.

From The Blog of HORAN Capital Advisors

The TRIX Indicator Signaling A Little Lower Level For The Market

At this point in time we remain positive on the longer term direction of the equity market. By that, we are not expecting this bull market to revert to a full blown bear market. Market pullbacks seem few and far between of late, but are healthy and necessary in order to sustain a longer term trend like the one investors are enjoying since the end financial crises in 2009.

From The Blog of HORAN Capital Advisors

Source: Doug Short

The catalyst for the current market pullback certainly is different. The oversupply in oil and the resultant rapid contraction in oil prices was not a factor on investors minds just a few short months ago. Contributing to the oversupply in oil is the fact oil demand also seems to be on the decline. The question for investors and the market is whether the supply/demand issue is the result of a broader economic slowdown globally. This unanswered question is contributing to the equity market's recent decline.

Oil dominated economies like Russia's have been negatively impacted by this price decline. In order to address the negative impact of the oil price decline and the weakness in the Ruble, yesterday, Russia's central bank increased its key interest rate to 17% from 10.5%. Also, a melt up in long term treasury bond prices is an outcome nearly no one predicted at the beginning of 2014. Even if treasury bond prices turn lower (rates rise) the article referenced in the just noted link indicates bond prices do not experience crashes like stocks do in their downturn.

At HORAN we constant evaluate fundamental data related to company earnings and the economy. Also, we believe reviewing technical data specific to stocks and the economy is a valuable input in investment decisions. Investors should note it is impossible to predict market bottoms to the day. From a technical perspective then, as we look at just the S&P 500 Index, we do believe the market is nearing a bottom, but maybe not quite there as can be seen in the below chart. No single technical indicator is a panacea to the timing of a particular stock purchase or sale. With this said, one indicator investors might find useful the TRIX momentum indicator. This indicator is a momentum oscillator that displays the percent rate of change of a triple exponentially smoothed moving average. The TRIX is designed to filter out insignificant price movements. As shown in the below chart the TRIX experienced a crossover in early December and has yet to reach a low or at least cross below the zero center line. On a weekly basis, the TRIX attempted a cross above the signal line which appears to have failed as can be seen in the chart at this link. Lastly, the below chart also shows the S&P 500 Index closed just below its 150 day moving average. The market will need to reclaim the 150 day M.A. or else the 200 day MA at 1,947 will come into play as the next support level.

From The Blog of HORAN Capital Advisors

Wednesday is a Fed announcement day which will cause potentially more market volatility. Friday is a quadruple witching day and this often results in higher trading volume as well as increased market volatility. As stated earlier, no one technical indicator will indicate a turning point in the market; however, these type of indicators provide some insight into the sentiment around the market and/or particular investments.

The market seems to be hoping for the so-called Santa Claus rally so we will see if the Fed helps make this happen in their Wednesday statement. As Charles Kirk of The Kirk Report noted in his evening strategy report to members,

While probabilities are good for a post-Fed, Santa bounce back, the price action has not confirmed that bullish scenario. In addition, we still don't have any bullish reversal setups to work with as the series of lower lows, low highs continues to unfold.

Tomorrow is Fed day and expectations are high that Fed and Janet Yellen will do or say something to save Christmas from the Grinch this year. From a price action perspective, we don’t have any indication of that yet but we will continue to keep our eyes open and trade what we see, not what we expect or want to see instead.

From The Blog of HORAN Capital Advisors

Source: The Kirk Report

Week Ahead Magazine: The Factors Behind The Decline In Oil Prices

I suspect oil price movements will continue to garner many of the headlines during the coming week. During the past week, most of the economic reports were either positive or neutral.

• retail sales came in better than expected along with a spike higher in consumer sentiment.
• the release of the Fed's Labor Market Conditions Index for November was the lowest since January 2014 which suggests a softening labor market.
• the Job Openings and Labor Turnover report was essentially unchanged for October (December report).
• inflation continues to remain in check at the producer level as the producer price index ex food and energy was flat for November. When food and energy is included, the headline PPI declined .2%.
• import prices continue to decline by dropping 1.5% in November. This decline in import prices has been a trend in place since the beginning of the year.

From The Blog of HORAN Capital Advisors

This leads to expectations for the week ahead. One significant report for the week will be the FOMC meeting announcement on Wednesday. The market is expecting the Fed to remove/change the language in its statement regarding the timing of the next Fed rate increase. The current language indicates the hike will not occur for an "extended time." The market expects some change in this part of the Fed statement. As last week's reports on PPI, import prices and labor market conditions, it seems apparent inflation and the job market are not heating up. Given this information, and including the collapse in oil prices, a rate hike would seem to occur no sooner than mid year 2015. Other reports for the week that might be most impactful to the market are:

• industrial production (M)
• housing starts and flash manufacturing PMI (T)
• consumer price index and FOMC meeting announcement (W)
• jobless claims, Philadelphia Fed Survey and Leading Indicators (Th)

A number of articles in this week's magazine look at the factors behind the fall in oil prices. As we have noted in several posts over the course of the past few weeks, we believe supply is only one factor driving prices lower. An article or two in the magazine note the impact that lower demand is having on oil prices as well. Broadly, this lower demand has implications for the strength of the global economy. For sure economic activity outside the U.S. has been slowing in many countries. For the moment the U.S. economy seems to have disconnected from the slowdown impacting the euro-zone and China, to name a few regions. A question then arise about the reality on what has once been a global synchronized growth story, if a globally connected world can truly operate on opposing economic cycles. Broadly, this is what the market may be trying to figure out, especially if one believes oil demand, or lack thereof, is also a cause for the drop in a price of oil. Below is the link to this week's magazine.

• The Week Ahead Magazine: The Factors Behind The Decline In Oil Prices

Energy's Ripple Effect Or Is It A Tidal Wave?

Crude oil prices continue to take a beating and are seemly dragging the entire market lower this past week. A market concern now is the fact the price of a barrel of WTI crude has broken longer term support that had been in place for twenty years as can be seen in the chart below.

From The Blog of HORAN Capital Advisors

Market participants have a new worry if crude does not rebound to reclaim this long term support level--the free fall will continue. The next support level is just above $50 per barrel and if that does not hold, the mid $30 per barrel price could come in to play.

More importantly, fundamentally, what is behind this price decline? The fact OPEC could not come to an agreement on production reductions has put the blame for the decline on oversupply. Supply is a significant contributor to the decline. We also believe demand for oil is playing a role as well as we noted in a post earlier this week. Earlier this month OPEC reduced its 2015 demand forecast and Friday the International Energy Agency reduced oil demand for 2015. The issue that rises to the top then is whether or not this potential demand reduction is a sign of a global economy that is entering a period of significantly slower growth, i.e., entering a global recession. At this point in time we believe this does not occur and the U.S. weathers the slow down that is occurring outside its borders.

From a pure technical perspective we believe oil and energy related stocks are trading at extreme oversold levels. The first chart below is WTI crude and the technical indicators below the chart are indicating extreme oversold levels and possibly a bounce can occur in the coming trading days. Additionally, the S&P energy sector as represented by the SPDR Energy Sector ETF (XLE) is similarly trading at oversold levels.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

As they say, "the trend is your friend" and in the case of oil and energy, the trend is in the wrong direction. Investors stepping up to buy into this sell off in those stocks negatively impacted by the energy slide feel as though they may be catching a falling knife. However, for long term investors, a number of stocks are beginning to offer entry points that could be rewarding longer term.

Is The Recent Market Decline Really A Rout?

On a price only basis the S&P 500 Index is down 3.86% from the high reached on December 5, 2014 and headlines describe this recent market action as a "rout" or a market "tumble." I do not intend to pick on the publishes of the below headlines as many articles have highlighted the recent market action in this way.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

These dramatic headlines can cause investors to loss sight of the real market action, and more importantly, the potential direction of the market as one looks ahead. I would not argue with the fact that one market sector has "tumbled," the energy sector. Other than the energy and telecom sector, investors have enjoyed respectable returns to date in 2014. Also, the S&P 500 Index remains up 11.8% in 2014 through today's close. This double digit return is on top of the 32+% return for the S&P 500 Index in 2013.

From The Blog of HORAN Capital Advisors

Below is a weekly chart of the S&P 500 Index. As evidenced by the chart, until this week, the S&P 500 Index has closed up for seven consecutive weeks. One fact that is a given is the market will not move higher every week of the year.

From The Blog of HORAN Capital Advisors

As 2014 is rapidly nearing a close, investors should be evaluating the catalyst for this recent pullback as we are at HORAN. The main factor that seems to have caused the recent decline is the decline in oil prices. An obvious question investors may have is what industries and market segments benefit from the decline in oil prices. Sector beneficiaries that rise to the top are some types of retail as consumers have more cash to spend, trucking, rail and airlines. As we have pointed out to clients we have met with recently, we think the oversupply of oil is only one factor. We also believe the demand side of oil is contributing to the decline in oil prices. In a recently released 100 page report by OPEC, it is noted that OPEC is also projecting a decline in oil demand in 2015 as can be seen in the below table taken from the report.

From The Blog of HORAN Capital Advisors

Source: OPEC.org (pg 89)

The slowdown in the emerging markets, especially in China, and the weaker economies in the eurozone and Japan all contribute to the reduction in the demand for oil. For now the U.S. economy seems to have disconnected from economies outside its borders and continues its "bump along" growth pace. Is this sustainable in the face of a broader economic slowdown?

At the beginning of 2014 most strategist believed long bonds would not be a good investment as interest rates were expected to rise. Rates have actually declined and the iShare 20+ Year Treasury Bond ETF (TLT) is up over 20%. Many strategist believed Europe was turning the corner and this would be reflected in positive relative equity prices in 2014. The opposite has actually occurred. Now some believe most of the bad news is priced into eurozone equties (Time to overweight eurozone stocks? by Jim Paulsen, Ph.D of Wells Capital Management) so is it time to allocate investments there?

In short, the recent equity market pullback is not a significant one. Could the decline materialize into a larger one? Most certainly. At the moment we do believe the U.S. economy will be a net beneficiary of lower oil prices. Some sectors that should benefit from lower oil prices, like the rails, have pulled back subsequent to the spike they enjoyed when the oil price decline began to accelerate as can be seen in the chart below. The advice for investors is if they are trying to buy the dips, understand why a stock or sector has declined.

From The Blog of HORAN Capital Advisors

Other market segments such as energy MLPs have pulled back as well. Some believe this is a direct result of the decline in oil. Some MLPs, for example pipelines, are not directly impacted by oil price movements since pipeline MLPs generally get paid based on the volume of oil that runs through the pipeline. However, if demand is lower, volume could be less for sure. thus negatively impacting earnings.

We also believe there is a political factor impacting MLP prices. Incoming House Ways and Means Committee Chairman Paul Ryan desires to overhaul business taxes in 2015. As reported by the Wall Street Journal, Ryan has indicated he wants to see changes to those companies and partnerships that are structured in a way they pay individual income taxes instead of corporate taxes. To us this sounds like a potentially negative tax impact for MLPs, REITs and S-Corporations. The point for investors is MLPs may be down in price for more reasons than simply oil related ones so do not buy the dips blindly.

In conclusion, this current pullback may not be at an end; however, looking out to 2015, we do believe equities will provide investors with positive returns. A recent report from Charles Schwab, Why Global Economic Policy Is Likely to Boost Growth in 2015, provides a positive perspective on the fiscal and monetary policies around the globe and how the 2015 policy can benefit specific global regions. Improved global growth would certainly be a positive for equity prices.

Week Ahead Magazine: A Seasonally Favorable Period For Equities

Washington, D.C. will likely do its part in grabbing headlines this week due to a potential government shutdown starting December 12th. Congress has until December 11th to approve a government funding bill before recessing on the 12th. Investors should keep in mind any market gyrations around these shutdown periods is more emotional than fundamental as we noted in a post in October of 2013, Government Shutdown: Time To Buy Or Sell Stocks?

With this thought out of the way, as we look to the week ahead, a number of article links in this week's magazine highlight the seasonally strong period for the market at this time of year. Some of the articles look at this part of the calendar as the so-called "Santa Claus Rally", while other articles incorporate the strong 6th year of the Presidential Cycle. In any event, from a technical perspective this part of the calendar tends to favorable for equities. The decline in oil prices continues to dominate a few article links as well. The decline in oil prices is anticipated to put pressure on some of the marginal energy producers; thus, making them ripe for a takeover by the larger and better capital oil firms.

Lastly, the economic report calendar is fairly full with the following reports likely to have the most impact on the market. The most important report this week will be the retail sales report on Thursday.

• JOLTS and Wholesale Trade (T)
• EIA Petroleum Status Report (W)
• Jobless Claims, Retail Sales, Business Inventories and EIA Natural Gas report (Th)
• Producer Price Index and Consumer Sentiment (F)

Following is the link to this week's magazine.

• The Week Ahead Magazine: A Seasonally Favorable Period For Equities

Evaluating Potential Changes To Index Holdings

Effective on December 4th Bemis (BMS) was moved to the S&P Midcap 400 Index from the S&P 500 Index. BMS was replaced by Royal Caribbean Cruises (RCL). RCL was formally a member of the S&P 400 Midcap Index. On an ongoing basis S&P Dow Jones Indices evaluates the companies that comprise their various indices. A number of factors are required for a particular company to be included in an index and for that matter to be removed. Importantly, S&P notes, "...an index constituent that appears to violate criteria for addition to that index is not deleted unless ongoing conditions warrant an index change."

Keeping in mind the factors used by S&P as detailed in the above link, Bemis had a market capitalization of approximately $4.1 billion and Royal Caribbean's market cap was  $17.4 billion at the time of their index changes. From an unadjusted market capitalization perspective, S&P currently uses the following guidelines for each respective index.

• S&P 500 Index: $5.3 billion or more.
• S&P Midcap 400 Index $1.4 billion to $5.9 billion.
• S&P Smallcap 600 Index $400 million to $1.8 billion

Below is a list of those companies in the S&P 500 Index that have the smallest market caps and those companies in the S&P Midcap 400 Index that have the largest market caps.

From The Blog of HORAN Capital Advisors

Full View

Not surprisingly I suppose, conclusions are mixed as to whether it is a positive or negative to be added or deleted from the Index (here, here and here). Many reasons can result in a company being added/removed from the index. For example, removal can occur because a company's business prospects are declining and in that case future stock performance may be weak. On the other hand, a company may have sold portions of their business resulting in a smaller capitalized company that may actually perform well going into the future. One of the white papers at a link noted earlier in this paragraph concludes stocks added to the S&P 500 Index underperform due to the application of a larger discount rate because of potentially higher stock price volatility. For investors, understanding why a firm is added or deleted from an index is important. Evaluating a company's long term business prospect is more important than whether or not it is in a particular index.

Dividend Payers Return Trailing Non Payers Through November

One aspect of the investing climate in 2014, due to the Fed's low interest rate policy, has been investor interest in dividend yielding equities. Finding dividend payers from companies that comprise the S&P 500 Index has become less difficult over time as more companies within the index pay a dividend. As the below table shows, 423 issues in the index now pay a dividend. From a performance perspective, we have highlighted the returns of the payers versus the non-payers from time to time.

In looking at the returns below, on an average return basis the non-payers of the index have outperformed the payers through the first eleven months of this year, 15.58% versus 14.57%, respectively. Comparatively though, both the payers' and non-payers' average return has outpaced the cap weighted return of the S&P 500 Index itself. A part of the reason behind this has been the underperformance of a number of the mega cap stocks.

The second chart below compares the price return of the Guggenheim Russell Top 50 Mega Cap ETF (XLG) to the S&P 500 Index. The mega cap stocks have underperformed the S&P 500 Index by almost 100 basis points or one full percentage point.

From The Blog of HORAN Capital Advisors

Source: S&P Dow Jones Indices

From The Blog of HORAN Capital Advisors

The fact the Fed has stated it has ended the quantitative easing programs is no longer new news. Given this fact, it is anticipated the Fed will begin raising interest rates sometime in 2015. In a rising rate environment stocks can continue to perform well; however, the initial rate move can result in equities briefly turning lower. Some yield sensitive assets dropped lower this morning after the release of the job report, specifically REITs and utilities. Consequently, investors will need to be aware of the sensitivity of yield equities (and bonds for the matter) when rates are initially increased.