Monday, August 22, 2016

What A Difference A Day Makes: The Calendar Roll

The S&P 500 Index was essentially flat today, down .06%; however, an investor's one year price only return will increase over three full percentage points from last Friday's close to today's close. For an investor invested in the S&P 500 Index, Friday's (8/19/2016) one year price only return equaled 7.28% and one day forward to Monday's close, the investor's one year return increases to 10.74%. The reason for this is the calendar rolling forward one day, weekends result in some nuances, and August of last year was a volatile month to the down side for the market and this is contributing to the magnitude of the change in return.

This same impact is resulting in large spikes in the one year rolling return for energy as energy prices were in the upper $30 range versus today's $47.41. As time moves forward to year end, energy was falling into the mid $20/bbl area and if oil prices stay near current levels, the year over year price increase will be significant, nearly a doubling of the price of oil.

The interesting dynamic will be the impact on year over year earnings for the S&P 500 Index. S&P Dow Jones Indices has reported that the fourth quarter of 2015 as reported (bottoms up) earnings per share for the S&P 500 Index equaled $18.70. Projected bottoms up per share earnings for the S&P 500 at 12/31/2016 equals $29.30. On a year over year basis, earnings growth will equal over 56%.

Some of the recent equity market strength is a result of this anticipated improvement in earnings growth for companies and it will be significant assuming it continues on its current path. As is often the case, the stock market follows earnings (flat earnings in 2015 and flat equity returns) and the YoY double digit S&P 500 return is moving towards the YoY 16.6% anticipated growth rate for bottom up earnings in Q3 2016. Not sure I would want to be a stock market bear at the moment.

Saturday, August 20, 2016

Some Favorable Market Technicals But Awaiting A Resumption Of Earnings Growth

For the better part of a month the S&P 500 Index has traded in a very narrow range. Some strategists believe the market has come too far too fast since the June low and a correction is necessary before the market moves higher. We have noted from time to time that corrections can occur in price, i.e., a decline or in time, i.e., trade sideways for an extended period. At this point in time it appears the S&P 500 Index is attempting to go through a corrective phase by trading sideways over time. Of course, the length of time required to qualify for a correction over time is unknown. I believe one key determinant for this market is earnings over the course of the next four quarters which I will discuss later in this post.

One positive indicator on the above chart is the On Balance Volume indicator. The OBV measures volume on up days and volume on down days and accumulates the data over time. It is the trend of the OBV line that is important. If the line is trending up, trading volume is higher on up days versus down days and is an indication of buying demand. Up until this week equity fund and ETF flows were strongly negative. In Lipper's fund flow report earlier this week it is noted investors turned more favorable towards equities as equity flows turned positive with money market flows a negative $20.8 billion. The Money Flow Index (MFI) in the above chart is a volume weighted version of the Relative Strength Index (RSI). The MFI is not at a level indicative of an over bought market and similarly, the RSI is not at an over bought level either as can be seen in the below chart.

Investor bullish sentiment as reported by the American Association of Individual Investors has move to a more neutral level at 35.6%. The bullish sentiment reading has increased from the low 17.8% at the end of May, but is far from overly bullish. And true to form, the market has advanced 4.4% since investors indicated their low level of bullishness in May; hence, the reason the AAII sentiment readings are viewed as contrarian ones.

And lastly, I believe a key factor in resolving the market's sideways pattern is the anticipated resumption of earnings growth. In Thomson Reuters weekly earnings report several favorable data points continue to unfold.
  • Of the 479 companies in the S&P 500 that have reported earnings to date for Q2 2016, 71% have reported earnings above analyst expectations. This is above the long-term average of 63% and above the average over the past four quarters of 70%.
  • In aggregate, companies are reporting earnings that are 4% above estimates, which is above the 3% longterm (since 1994) average surprise factor, and in line with the 4% surprise factor recorded over the past four quarters.
  • The estimated earnings growth rates for the S&P 500 for Q2 2016 through Q2 2017 are -2%, 0%, 8%, 15% and 13%, respectively.
Certainly, the month of August has yet to come to an end and the September/October months can be volatile ones. Included in the mix this year is the presidential election and an uncertain Fed. All said though, if earnings growth does resume over the next four quarters, longer term investors are likely to be rewarded over the course of the next year or so, but a straight line move higher is most unlikely.

Friday, August 19, 2016

Highlights From S&P Dow Jones Indices Dividend Aristocrats Update

S&P Dow Jones Indices recently provided an update on the performance of the S&P 500 Dividend Aristocrats Index compared to the S&P 500 Index. It should be noted the Aristocrats index is an equally weighted index that is rebalanced quarterly. Index members are determined annually based on December year-end information with changes effective at the end of the subsequent January. I have written about the importance of dividends a number of times on this blog and this recent S&P update verifies the important role dividends play in an equity's total return. This post will provide some highlights from the S&P report and readers are encouraged to read the entire research paper.

Although dividends have accounted for a smaller percentage of the the total return for the S&P 500 Index over the past several decades, dividends remain an important component due to the favorable impact dividends have on compounding. As the below chart shows, since 1929 dividends have accounted for over one-third of the return of the S&P 500 Index.

And as the two following charts detail, over a longer period of time, the compounding impact to returns has been significant.

In order for a stock to be considered for inclusion in the Aristocrats Index a company must be a member of the S&P 500 Index and have increased its dividend for a minimum of 25 years. The Index consists of 50 companies and the sector composition relative to the S&P 500 Index is noted below.

The largest sector difference occurs with consumer staples and information technology where the Aristocrats' staples weighting is 26.2% versus 10.1% for the S&P 500 Index and the technology weighting for the Aristocrats is only 1.9% versus 20.6% for the S&P 500 Index.

Another unique factor associated with the Aristocrats is the overall Quality Ranking profile is a higher quality one versus the broader S&P 500 Index itself. The importance of this factor is higher quality stocks, tend to be dividend payers, and have the characteristic of holding up better in down markets as the S&P Dividend Aristocrats report covers in detail.

A common variable of higher quality stocks is the fact they pay a dividend and dividend growth companies tend to carry less of a debt load on their balance sheet.

Since I am discussing dividend aristocrats, including a comment on the dividend yield seems appropriate. Of course, the Aristocrats Index basket of stocks carries a higher dividend yield versus the S&P 500 Index, 2.56% versus 2.24%, respectively.

In conclusion, our firm believes dividends are important, with the larger issue being the dividend provides insight into a company's cash flow. It is cash flow that pays the dividend and enables a firm to grow. Consequently, we invest a portion of our clients' portfolios in companies that do not pay a dividend, but do exhibit strong cash flow characteristics. However, analysis around the dividend can provide important signals for investors that may trigger a sell decision. For example, a company may be borrowing in order to maintain a certain dividend growth rate or a company's payout ratio may be increasing. These tangible factors can provide investors with an early warning to companies that may be facing headwinds currently or in the near future.


S&P 500 Dividend Aristocrats
S&P Dow Jones Indices
By: Smita Chirputkar and Aye M. Soe, CFA
August 2016

Wednesday, August 17, 2016

Individual Investors Still Love Apple

From time to time I review the most active stocks by individual investors as compiled by Better Investing Magazine. I last updated the list in March and the two stocks that dropped off of the most active list from that time are Under Armor (UA) and Netflix (NFLX). The new additions are Wells Fargo (WFC) and Southwest Airlines (LUV). Apple (AAPL) has remained at the top of the list as far back as January 2015. Below is the most recent active list.

Tuesday, August 16, 2016

Should Investors Worry More About A Bond Or Stock Market Correction?

A great deal of commentary over the past few days has focused on the recent equity market trifecta, i.e., the Dow Jones Industrial Average, the S&P 500 Index and the Nasdaq Composite Index all hit new all time highs on the same day and the heightened potential for an equity market correction. Over the past week or so, LPL Financial Research has published some good analysis around the broad index participation in new highs and potential future market outcomes. Since 1980 12-month rolling returns have been positive 76.5% of the time. As the below table shows, when the Dow, S&P 500 and Nasdaq hit all time highs on the same day, the 12-month forward return is positive 75% of the time and averages 11.9%. I would recommend readers read the LPL article.

Equities have certainly had a nice move to the upside following the February market lows. And given the strength of this move, some downside consolidation would be expected. However, simply because the three indexes hit new all time highs, this does not mean stocks are necessarily due for a correction.

What investors might not be focused on though is the strength in fixed income returns this year. As the year got underway, market expectations were the Fed could raise the Fed Funds rate up to as many as four times over the course of 2016. Now, if we get one rate increase, that might be all the market will need to digest in 2016. As a result of this lower trajectory in potential rate increases, fixed income returns have far exceeded many investors' expectations. The below chart clearly shows the strength of a select few fixed income vehicles along with the S&P 500 Index.

The S&P 500 Index year to date return has trailed the return of the long term Treasury Index and high yield index. Additionally, with these strong returns in a number of fixed income categories, should investors be more concerned about future bond returns than future stock returns? The iShares High Yield Bond Index (HYG) has hit a record high and the 30-year Treasury yield is near a record low and I am only showing a couple of examples.

For investors, if one year forward corporate earnings meet expectations, this could be one tailwind for stocks. We have discussed this in several earlier posts along with the fact economic data is largely coming in better than expected, not only in the U.S. but in Europe as well. Some of these variables suggest there is greater potential downside risk in some bond categories and the stars may be aligning for further upside in stocks over the next twelve months. Higher equity prices certainly will not unfold in a straight line though.

Update (8/17/2016-2:35pm): One reader suggested we refer our readers to the following link (WHAT GOES UP…) which contains a counter perspective to the LPL piece. I think it is an interesting viewpoint that is worthwhile for readers.

Thursday, August 11, 2016

History Suggests Record Equity Market Highs Do Not Mean Investors Should Sell Stocks

In late January and then in mid February I wrote posts noting our firm's positive view on the equity markets (here and here). It was a difficult position to take at the beginning of the year with the market in decline. As of the close today. and the first time since 1999, the S&P 500 Index, the Dow and the Nasdaq hit highs on the same day. Both the Dow and S&P 500 Index are up nearly 7% year to date. A number of high profile (often bearish though) investors/strategists are calling for a severe market correction. Knowing foresight is never perfect, should individual investors get out of equities now? History does not guarantee the future; however, the future tends to rhyme with the past.

LPL Financial Research published an interesting report today that addressed the question of, should an investor sell everything? Included in the report is a brief discussion on sentiment as well. A couple of worthwhile bullet points from the report:
  • There have been 40 other times the S&P 500 was up more than 6% for the year with 100 days to go (like 2016), and incredibly, the rest of the year is up 5.3% on average and higher 90% of the time.
  • Thus, a strong start to the year has led to even stronger returns for the rest of the year.
  • What about the full-year returns? Only once in history has the S&P 500 been up more than 6% with 100 days to go and finished red, and that was in 1929 (emphasis added).

The equity market will certainly experience some pullbacks; however, the positive economic data noted in earlier posts along with some not so bullish investor sentiment today, suggests this market seems to want to trend higher into year end.

Monday, August 08, 2016

Buyback Index Trails Broader S&P 500 Index

In an article earlier today I noted how corporate buybacks over the last two plus years have far outpaced U.S and foreign investors' outflow from equity investments. This strength in buybacks has not translated into outperformance for these buyback firms relative to the S&P 500 Index though. As the below chart shows, the cumulative total return performance of the Powershares Buyback Achievers ETF (PKW) has lagged the cumulative total return of the S&P 500 Index during the last two years. As background, the US BuyBack Achievers Index is comprised of US securities issued by corporations that have effected a net reduction in shares outstanding of 5% or more in the trailing 12 months.

The underperformance became more pronounced beginning in the fourth quarter of 2015. Comparing the two year results above with the one year returns shows the S&P 500 Index has returned 6.29% versus -.43% for PKW over the last 12-months. One headwind that has faced buyback focused investors is the yield differential on the buyback index versus say the iShares Select Dividend ETF (DVY). The yield on PKW is 1.4% and DVY has a yield of 3.0%. In this environment where investors prefer income, PKW's yield is even lower than the S&P 500 Index's yield of 2.1%. Historical stock buyback activity can be found at my post, Stock Buybacks Up Double Digits In First Quarter.

Most Everyone Is Bearish On Equities Except Companies

Last Friday the S&P 500 Index closed at its daily high of 2,182.87 and this equated to a 20.6% advance since the February 11th intra-day low. In spite of this strong advance from the February low and a price only return of 6.8% this year, most investors remain bearish on stocks.
  • This bearishness has translated into equity outflows of mutual funds and ETFs with bond investments capturing much of the inflows.
Source: ICI

Friday, August 05, 2016

Jobs Were The Missing Link?

The equity market's reaction to the above consensus job report today would make one believe the only missing link in the economic recovery was today's job's report. The 255,000 increase in nonfarm payrolls exceeded the consensus of 185,000 and the top range of 215,000. The end result is the S&P 500 Index was able to breakout of its sixteen day trading range.

Tuesday, August 02, 2016

Oil And Equity Price Trend Conundrum

A part of the anticipated improvement in forward earnings for the S&P 500 Index is an improvement in the energy sector. The health in the energy sector has spillover into other sectors of the market like the industrial sector that sells into the energy space. Of late, however, oil prices have pulled back significantly from over $50/bbl in June and dropping below $40/bbl yesterday. This decline in price can be directly attributable to the elevated supply of crude.

Saturday, July 30, 2016

Income Oriented Equities Lag In July

In a few recent posts I have discussed the elevated valuation of dividend growth equities. It would appear bond investors have gravitated to the anticipated safety of equities that generate dividend income greater than can be found in the low rate bond market. The extended valuation of these income equities/sectors may result in investors being surprised in the event the market does encounter a pullback. In fact, August and September tend to be the the poorer performing months for stocks.

Just as the "sell in May' mantra has yet to play out this year, maybe the much anticipated August/September weakness becomes more discussion than reality. And given all the concern about this late summer weakness, in July, investors seemed to rotate out of the so-called safe income stocks and into the higher beta, more cyclical equities. As the below chart shows, the income oriented equity market segments underperformed the broader S&P 500 Index and the PowerShares S&P 500 High Beta ETF (SPHB).

From a sector perspective, the more defensive sectors in the S&P 500 Index lagged the more cyclically oriented ones as well. Energy has its own issues and the other bottom three performing sectors in July were Consume Staples, Utilities and Telecommunications. On a year to date basis the performance of these three sectors remains strong; however, Technology, Materials, Health Care and Industrials generated strong returns in the month of July. An important factor for continued strong performance in the cyclically oriented sectors is improved earnings.

In Thomson Reuters This Week in Earnings report, they note,
"312 companies in the S&P 500 Index have reported earnings for Q2 2016. Of these companies, 72% reported earnings above analyst expectations, 12% reported earnings in line with analyst expectations and 16% reported earnings below analyst expectations. In a typical quarter (since 1994), 63% of companies beat estimates, 16% match and 21% miss estimates. Over the past four quarters, 70% of companies beat the estimates, 9% matched and 21% missed estimates. In aggregate, companies are reporting earnings that are 4% above estimates, which is above the 3% long term (since 1994) average surprise factor, and in line with the 4% surprise factor recorded over the past four quarters."
Absent the energy sector, overall earnings appear to be on an improving trend. With respect to the energy sector, year over year comparisons will become easier starting with the third quarter.

Given the tight range the S&P 500 Index has traded in over the last two weeks, a break to the upside or downside will certainly occur. Historically, these tight trading ranges tend to resolve themselves to the upside. Having noted this, a little consolidation of the market gains since February would be healthy and not a surprise given the upcoming weak seasonal market months. And finally, investors chasing yield in stocks need to be cognizant of the rich valuations of these stocks and recent rotation may indicate some investors are figuring this out.