State Street Update: Stock Declines 6.5% on Acquisition Announcement

Today State Street Corp. (STT) announced a $4.18 Billion acquisition of Investor Financial Services Corp. (IFIN). State Street's stock closed down $4.67 or 6.5% and IFIN rose $12.85 or 27.37% on the news.

As I noted in my post dated 12.22.2006 titled State Street Raises Dividend...But STT's dividend has been slowing. In the post I suggested maybe the slower dividend growth was an indication by the board of directors that STT's business was slowing. I have noted in other posts that slower dividend growth could be an indication the board/company might have other uses for the cash, such as acquisitions or stock buybacks. In any event, was STT's slower dividend growth rate a signal of a pending acquisition? Those companies that begin to exhibit slower dividend growth warrant further research by investors. An investor must be comfortable with the business strategy of these investments.

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January Barometer: What Does This Suggest?

An often cited mantra on Wall Street is "as goes January, so goes the year". This January saw the S&P 500 Index rise 1.4% thanks to an increase of 1.2% during the last two trading does of the month. According to Standard and Poor's, the 1.4% advance is equal to the average return in January since World War II. Following is a chart from Chart of the Day detailing historical returns for the S&P 500 Index in the months following a January that achieved positive returns. Chart of the Day notes:

"...(the) chart presents the average performance of the S&P 500 one, three, six, and 11 months following a January gain (blue bars) and following a January loss (gray bars). The chart illustrates that the S&P 500 has performed much better (on average) during the months following a January gain. In fact, 11 months following a January gain; the S&P 500 was up 89% of the time..."

Source: Chart of the Day, Standard and Poor's

Weekend Reading: 2.3.2007

• The free portion of the American Association of Individual Investors website highlights an article focusing on when to sell securities. In addition to the four rules listed below, the article discusses factors one should consider before simply pulling the trigger and selling a position.

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• A recent post on The Kirk Report website highlighted a link to a site containing the performance of sectors and industries over time. At times, identifying the correct segments of the market can be as important as selecting the correct stock in the short run. Click here for the link to the website containing the sector highlights.

• In addition to the above link, Valueline analyzes sectors based on projected earnings growth, PEG ratio and the PEGY ratio. A PEG ratio is the price/earnings ratio divided by the expected earnings per share growth rate. The PEGY ratio is the price/earnings ratio divided by the annual earnings growth rate plus dividend yield.

Source:
Parting Company: 4 Rules for When to Sell
American Association of Individual Investors
By: John E. Deysher
http://www.aaii.com/commentary/articles/200609_stockstrategies.cfm?ro=1640

Dividend Payers vs. Non-Payers Performance: January 2007

In January, the dividend paying stocks in the S&P 500 Index outperformed the non-dividend paying firms. The outperformance was evident for the 12-month period as well.

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Source: Standard and Poor's

Bemis Reports 10.5% Increase in Quarterly Dividend

Although Bemis (BMS) reported earnings below expectations last week, today the company announced a 10.5% increase in its quarterly dividend to 21 cents a share versus 19 cents a share in the same period last year. This represents the 24th consecutive year Bemis has increased its dividend. The estimated payout ratio on 2007 earnings of $2.02 is approximately 42% versus the 5-year average payout of 40%. Additionally, the company announced a 3 million share increase in its stock buyback program.

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Bullish Sentiment Rises

The American Association of Individual Investors sentiment survey results for 2.1.2007 show an increase in bullish sentiment for the period ending 2.1.2007. The AAII Sentiment Survey tends to be a volatile contrarian indicator; however, last week's drop in bullishness has resulted in a relatively strong market this week.

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Source: American Association of Individual Investors

McGraw-Hill Increases Dividend 12.9%

Today, McGraw-Hill (MHP) announced a 12.9% increase in its quarterly dividend to 20.5 cents per share versus 18.15 in the same period last year. S&P does not provide a quality ranking for MHP since MHP is the parent company of Standard and Poor's.

The payout ratio for the new dividend based on 2007 estimated earnings is 28%. This compares to the 5-Year average payout for MHP of 31%. The new yield on the stock equals 1.22% versus 1.08% on the prior dividend.

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928 Days Since S&P 500 Index had a One Day 2% Decline

An interesting analysis of the S&P 500 and 2% correction chart at this link. This certainly makes one feel as though a correction is due for whatever reason. On the other hand, the more we hear about a correction, maybe the less likely there will be one.

Weekend Reading: 1.27.2007

• On the American Association of Individual Investors website is an article titled Cutting Through the Bond Market Fog when Shopping for Munis by Annette Thau. Obtaining information on bond prices is not nearly as easy as accessing information on bonds--both taxable and tax-free. The article provides information and detail on a website containing bond information an investor may find useful: www.investinginbonds.com. A lead in to the article notes:
  

• "...this article discusses how to shop for municipal bonds, using the Internet both as a source of bonds for purchase, as well as for information. The focus is on pricing and comparison shopping."

• In an article on the optionetics website they discuss the implication of the recent increase in bearishness in a few sentiment indicators. One of the indicators highlighted is the AAII Sentiment Survey I note on this site on a weekly basis. The article notes:
  

• ...So, judging by the VIX, the put activity in the options market, and the AAII survey, there is convincing evidence that investor sentiment is turning bearish. As a general rule, it makes sense to remain cautious as bearish sentiment is rising because more stockowners might jump ship and move into the bear camp as stocks come under pressure. Selling begets more selling. However, it is also possible that Thursday represented a short-term period of capitulation or a situation where the market has been washed out of sellers. If so stocks can continue the long-term grind higher..."

• The Valueline website provides access to free research reports on the 30 stocks that comprising the Dow Jones Industrial Average.

• As tax time approaches, the Wall Street Journal, via a Yahoo link, recently noted investors should not be in a rush to file their 2006 tax returns. One reason is due to a change instituted by the IRS requiring providers of 1099 forms to break out tax free income subject to the alternative minimum tax. Some investment organizations, like Wachovia and Morgan Stanley, have been granted 30-day extensions from the IRS. This extension allows those organizations to delay mailing their 1099 forms by 30-days; thus extending the deadline to the end of February when the forms must reach their investors.
  

Municipal Bonds: Kentucky Court Case

As many of my blog readers invest in municipal bonds, I am providing information on a court case that would have important implications to municipal bond valuations. The case is Kentucky vs. Davis.

The basic issue of the case is whether a state has the authority to tax the interest on out of state municipal bonds held by residents of the particular state. The case was brought by George and Catherine Davis of Louisville, Kentucky. The issue is whether the state of Kentucky has the right to tax the interest on bonds issued by other states. The Davises' maintain Kentucky's policy of taxing out of state municipal bonds, but not income from Kentucky bonds, violates the Commerce Clause and the Equal Protection Clause of the U.S. Constitution. A Kentucky appeals court ruled in Davises' favor. The case has been appealed to the U.S. Supreme Court which is weighing whether to hear the case. On January 19th, the U.S. Supreme Court did not include this case on its argument calendar. The next opportunity to hear from the Supreme Court would be around February 20th.

One issue is the yield on bonds from high tax states tend to be lower. If the U.S. Supreme Court sides with the Davises, the value of bonds from the high tax states could decline by 1% to 4%. The states that could be impacted the most are:

• California
• Missouri
• New York
• Rhode Island, and others with big in -state tax advantages.
  

Conversely, states that do not have in state tax advantages historically have offered higher yields to attract investors. A few of those states are:

• Illinois
• Texas
• Washington, and others.

Investors that purchase individual bonds and hold them to maturity likely will not be impacted to a large extent since they will receive the principal on the bonds at maturity. This is the case so long as states do not decide to tax their own munis in the event the Davises ultimately prevail in their case.

Source:
Kentucky Bond Fight Confronts U.S. Supreme Court
Bloomberg.com
By: Joe Mysak
January 24, 2007
http://bloomberg.com/apps/news?pid=20601039&refer=columnist_mysak&sid=ac88CSwtmUb8

A Bomb In The Muni Market
Fortune Magazine
By: Jon Birger
February 5, 2007

Midland Company Raises Dividend 63%

The Midland Company (MLAN), a property and casualty insurance Company and headquartered near Cincinnati, Ohio, announced a YOY 1st quarter 2007 dividend increase of 63%. The new dividend rate is 10 cents per quarter versus 6.125 cents in the same quarter last year. This represents the company's 21st consecutive year of dividend increases.

Midland is a small capitalization company with an $860 million market cap. This company is an example of a lower yielding dividend paying stock that exhibits a higher dividend growth rate. The S&P Earnings and Dividend Ranking is A-. The yield on the new dividend is .89% versus .50%.

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Bullish Sentiment Sees Significant Decline

The American Association of Individual Investors sentiment survey sees a significant decline in its bullish reading. The bullish reading drops to 39.51% versus last week's 57.58% reading last week. As a contrarian indicator and on a standalone basis, this is actually a bullish reading for the equity markets.

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Dividend Aristocrats Performance: 1.24.2007

On a market cap weighted basis, S&P's Dividend Aristocrats continue to have a YTD performance edge on the S&P 500 Index and the Dow Jones Industrial Average as of 1.24.2007; however, the Aristocrats have fallen behind the NASDAQ index in large part due to the NASDAQ's 1.4% increase today.

The Aristocrat's YTD portfolio performance equals 1.60%:

• The NASDAQ = 2.10%
• The S&P 500 Index = 1.50%
• The Dow Jones Industrial Average = 1.30%

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Dividend Increases: Comerica and Praxair

Today Comerica (CMA) announced an 8.5% YOY increase in its quarterly cash dividend. The new quarterly dividend is 64 cents per share versus 59 cents in the same period last year. The payout ratio based on 2007 earnings estimates is 52% versus a 5-year historical average of 50%.

Also, Praxair (PX) announced a 20% YOY increase in its cash dividend. The new quarterly dividend is 30 cents per share versus 25 cents per share in the same period last year. The payout ratio on 2007 earnings estimates is 35% versus a 5-year historical average of 28%.

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Dividend Aristocrat Performance Update: 1.22.2007

On a market cap weighted basis, S&P's Dividend Aristocrats have outperformed the NASDAQ, S&P 500 Index and the Dow Jones Industrial Average year to date through 1.22.2007.

The Aristocrat's portfolio performance is .80%:

• The NASDAQ = .70%
• The S&P 500 Index = .30%
• The Dow Jones Industrial Average = .10%

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Chasing Returns

One reason international investments have been good performers for U.S. investors over the past few years is the weak U.S. dollar. Is U.S. dollar weakness a trend that will persist going forward? It likely is, but not against all foreign economies so selectivity will be an important aspect of ones returns from international investments.

Following is an excerpt from a recent Schwab Insight Report that highlights the comfort level of investing in yesterday's strong market performers.

Be the “Smart Money”
By Liz Ann Sonders, Chief Investment Strategist
Charles Schwab & Co., Inc.

You may have heard the terms “dumb money” and “smart money,” which typically refer to individual investors and professional investors, respectively. In reality, there is a lot of gray area, as there are many smart individual investors and quite a few dumb professional ones. But the “dumb money” term stems from the historic tendency for individual investors to act like lemmings, chasing past performance in the hopes of its repetition.

Take a look at the chart below, which shows the annual performance rankings of the broad asset classes, from best to worst, over the past 10 years. If there were ever a snapshot exemplifying why investors should be diversified, this quilt pattern is it. But there’s more: boxes bordered in black represent the year (specific quarter in box) during which an asset class saw peak mutual fund inflows. Conversely, boxes bordered in yellow represent the year (and quarter) during which an asset class saw peak outflows. It turns out that mutual fund investors have regularly poured money into asset classes after their peak, while bailing out closer to the bottom.

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Let’s take a few examples. In the first column, you’ll see emerging markets’ weak performance, followed by another brutal year in 1998. By the fourth quarter of 1998, investors threw in the towel and withdrew from emerging markets mutual funds at a record pace. This, of course, was just in time for 1999’s record-breaking return. Fast-forward to 2006, when in the first quarter, there were record inflows into emerging market funds, as investors were “chasing” the prior three years’ exceptional returns. This peak inflow was just in time for the big swoon between May and June of this year.

In 1998 and 1999, large-cap growth was a big winner, while smallcap value had terrible performance. Not surprisingly, investors left small-cap value in droves in 1999’s fourth quarter, just in time for it to top the performance rankings the next two years! On the other hand, the peak inflows into large-cap growth, in reaction to past performance, came in 2000’s first quarter, just in time for its abysmal three-year run. When investors finally decided to bail in 2002’s third quarter, large-cap growth went on to post big gains the next year.

I think you get the picture, and you can see the trend for the other asset classes. The bottom line: Don’t be a performance chaser. Stay diversified. Rebalance regularly. Be the “smart money!"

Source:
Be the "Smart Money"
Insights Report: Best Ideas For 2007 And Beyond
Charles Schwab & Co., Inc.
By: Liz Ann Sonders, Chief Investment Strategist
December 21, 2006
http://www.schwab.com/public/schwab/research_strategies/market_insight/investing_strategies/portfolio_planning/
be_the_smart_money.html?cmsid=P-1654150&lvl1=research_strategies&lvl2=market_insight&refid=P-1654134&refpid=P-1653933

Citigroup Announces 10.2% Increase In Dividend

Today, Citigroup (C) announced a year YOY 10.2% increase in its first quarter 2007 dividend. The new dividend of 54 cents per quarter compares to 49 cents in the first quarter of 2006. The projected payout ratio on 2007 estimated earnings equals 48%. The 5-Year average payout ratio for Citigroup is approximately 38%.

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Bullish Sentiment Jumps 1.17.2007

American Association of Individual Investors Sentiment Indicator jumps to 57.58% this week. This is the highest level since January 12, 2006 reading of 58.96%.

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Source: American Association of Individual Investors

Washington Mutual: Another Quarterly Dividend Increase

Today Washington Mutual (WM) announced earnings and a quarterly dividend increase. Earnings for the 4th quarter of 2006 totaled $1.06 billion versus $865 million in the same quarter of 2005. Of note though, the 4Q earnings included an after tax gain of $415 million as a result of Wamu selling WM Advisors, Inc.

From a dividend perspective, WM announced an increase in the 1Q 2007 dividend to 54 cents per share versus 50 cents in the same quarter last year. This recent dividend announcement represents a 1 cent increase over the 4th quarter 2006 dividend. WM has increased its dividend by a penny in each quarter since the 3rd quarter of 2000. The payout ratio based on 2007 estimated earnings is approximately 53%. The 5-Year average payout ratio for Wamu is 46%.

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Historical Dividend Yield

Market and Sector Turning Points?

Most equity markets around the globe, the U.S.market included, have experienced a steady rise since this summer. The S&P 500 Index gained 1.26% in December, its seventh straight monthly increase. In fact, over the last several years, the rising economic tide seems to have lifted most markets. Although many markets may seem to be overvalued, maybe not the U.S. large capitalization equity market, markets do not generally correct simply because they appear overvalued. At this point in the economic cycle, high quality dividend paying stocks can serve as a potential safe haven.

Below are a few highlights from the Hussman Fund's November Research and Insight newsletter titled, Profit Margins, Earnings Growth, and Stock Returns:

• The value of an investment is based on sustainable earnings and not just current ones, investors ought to be paying a lot more attention to profit margins.

• Corporate profits as a percent of GDP hit 13 percent in the second quarter, a 50-year high.

• Following the earnings plunge of 2001-2002, the recent economic rebound has put net income at about 8.5 percent of revenues, a 50-year high.

• For the S&P 500 companies, capital expenditures as a percent of revenue has fallen from 7.5 percent to 5.6 percent today.

• Financial companies-including investment banks, regional banks, real estate companies, and insurance companies-now contribute 28 percent of the S&P 500's total income.

• Profit margins are a bit like P/E multiples in that when they move from low levels to high levels, they can provide a tailwind to returns. On the other hand, when margins move from high to low levels, earnings growth becomes more challenging...

• When earnings are weak, investors become frustrated and unwilling to pay much even for a dollar of depressed earnings. The opposite is true after a long expansion in earnings.

Reading the entire newsletter will provide some perspective on the potential factors that might lead one to view the market as fully valued. The Hussman Funds' all equity mutual fund is classified as a long/short fund.

In this week's Barron's Streetwise section, Michael Santoli notes:

• ...the greatest risks lay in markets that are priced as if they hold no risk.

• Plenty of markets around the world appear to be close to this condition. Yet the market for big U.S. stocks is not among them.

• ...shares of household-name companies have lagged other asset-classes badly.

• Last year, nearly $140 billion-or 90%- of all inflows to stock funds went offshore. And small investors are doing what they always do, chasing last year's performers.

• All else being equal, this is bullish for U.S. shares, as the little guy is usually a contrary indicator at important market turns...

Lastly, highlights from the January 22, 2007 BusinessWeek's Business Outlook:

• the unemployment rate remains tight at 4.5% last month, only a tick above October's 51/2-year low.

• The bigger risk to the economy down the road is not weak growth but accelerating inflation.

• Expectations of lower rates have always been predicated on weaker consumer spending... real consumer spending appears to have grown last quarter by an annual rate of about 4%...

• Through December 26, Internet sales at U.S. sites for nontravel items during the holiday season were up 26% from a year ago, to $23.2 billion, according to an estimate by comScore Networks. The company says retail e-commerce outside of gas, autos and food now accounts for about 7% of all retail outlays.
  

• Gift-card sales are booming, a trend that boosts January receipts, often at the expense of retailers' December numbers.

• Prior to the holidays, the National Retail Federation Gift Card Survey projected a 34% jump in card buying from the previous year, to $24.8 billion.

• Average hourly pay of production workers in December grew 4.2% from a year ago, up from 3.2% in the same period last year.

• Income of production workers last quarter was up 6.4% from a year ago. Adjusted for inflation, the pace was the strongest since the boom of the late 1990's.

• While the acceleration in wage growth is great for consumers, it is not so comforting to the Fed.

Based simply on the above three points of view, it seems the markets/economy could be at an inflection point. Certainly many investors and strategists are saying the markets are due for some typr of correction. From a contrarian point of view, it is not likely the markets correct simply because they appear overvalued. Has the Fed possibly engineered a soft landing?

I really can't name a famous and wealthy market timer-so what is an investor to do? I believe focusing on those parts of the equity markets that have not increased at a rate similar to some emerging markets, provides some opportunity. Also noted in Barron's

Morgan Stanley strategist, Henry McVey "...the U.S. stock market is "the best house in a bad neighborhood," -- meaning the most attractive market in a cash-saturated, generally overpriced world. Still, as one real-estate truism suggests, if you buy the nicest house in a poor neighborhood, it's unlikely to be spared if things take a turn for the worse; it may just lose less value than others as the owners await a new buyer. That's worth considering in a universe where global markets trade in near unison, and where leveraged, professional "fast money" is setting the marginal price.

Sources:
Profit Margins, Earnings Growth, and Stock Returns
Hussman Funds
By William Hester, CFA
November 2006
http://www.hussmanfunds.com/rsi/profitmargins.htm

In Risky World, U.S. Is Better Bet ($)
Barron's Streetwise
By Michael Santoli
January 15, 2007
http://online.barrons.com/article/SB116865112549075860.html?mod=9_0031_b_this_weeks_magazine_columns

Strong Job Markets Dash Hopes For Rate Cuts ($)
BusinessWeek
By James C. Cooper
January22, 2007
http://www.businessweek.com/@@0pXBumQQLNcSUhYA/premium/content/07_04/b4018031.htm