Sunday, February 07, 2016

Weak Investor Sentiment Leading To Negative Fund Flows

The weak equity returns experienced by the markets since the beginning of the year have resulted in a low level of bullish investor sentiment. The Dow Jones Industrial Average Index and the S&P 500 Index are down on a year to date basis 7% and 8%, respectively. The Nasdaq Composite Index has fared even worse and is down 12.9% this year. The lack of positive equity momentum and weak bullish sentiment have led to investors reducing exposure to both stocks and bonds as evidenced by recent mutual fund flow data.

From The Blog of HORAN Capital Advisors

The above chart incorporates data through the end of last year. Below is a table from ICI showing weekly outflows have continued into 2016.

From The Blog of HORAN Capital Advisors
Source: ICI

In mid-January bullish investor sentiment, as reported by the American Association of Individual Investors, came in at 17.90%. The last time bullish sentiment was reported at this low of a level was in April 2005. Subsequent to the mid-January sentiment report, individual investor sentiment began to improve until falling two percentage points to 27.55% last week.

From The Blog of HORAN Capital Advisors
Source: AAII

As we noted earlier this month, we do not believe the U.S. economy is headed for a recession. Given all the pessimistic talk of late though, one would think we are in a recession now. Because sentiment is a contrarian indicator, and given the negative fund flow data, maybe the end of this pullback is nearer the end than investors are anticipating.


Saturday, February 06, 2016

The Dogs Catch A Bid

The Dogs of the Dow theory suggests investors select the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Index (DJIA) after the close of business on the last trading day of the year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year. Below is the 2016 Dogs of the Dow.

As the below table shows, year to date through Friday's close, the Dow dogs have outperformed the Dow Jones Industrial Index, -2.5% versus -7.0% . As the below table also shows, the average yield for the 2016 Dogs of the Dow of 3.97% remains higher than the overall DJIA yield of 2.96%. In this market environment where the market is struggling to gain any traction, the income yield on the stocks seems to have enticed investors to purchase, or at least hold these higher yielding stocks.

From The Blog of HORAN Capital Advisors

One aspect of market returns in 2015 was the narrow nature of stock participation. As we noted in our Winter 2016 Investor Letter, the FANG stocks were up over 60% last year on a cap weighted basis. So far in 2016, the average return of the FANG stocks is -12%. The outperformance of the Dow Dogs at the start of 2016 may be a larger indicator of investor interest in more value oriented equities. As the below chart details, growth style equities have been on a strong outperformance trend versus value since the end of the financial crisis. The brief return to value outperformance has occurred during short stints since 2009, but has been unable to gain traction on a longer term basis. Maybe this early trend in 2016 will be the theme for the remainder of the year. We discussed the growth value difference in our post at the end of last year, 2015 Was A Year For Growth Stocks And Only A Handful Were Needed.

From The Blog of HORAN Capital Advisors



Monday, February 01, 2016

Economic Weakness Centered In Energy/Materials Sector: Not A Recession Yet

A significant issue facing investors is determining whether the world is entering into a global recession. Certainly, economic activity in emerging markets has been challenged due in part to the strength of the U.S. Dollar. Global economies are also dealing with the collapse of energy prices and the negative impact energy weakness is having on the broader industrial sectors as energy capital expenditure cuts ripple through the economy. As noted in our post yesterday, historically, energy prices and equities have a positive correlation, that is, they move in the same direction. Intuitively this makes sense as a stronger global economic environment leads to a higher demand for energy resources. Since late 2013 this correlation broke down and energy prices began to move in the opposite direction of stocks. When January 2016 rolled around though, the correlation between oil and stocks once again turned positive.

Absent ongoing excess supply, weaker energy prices have been one signal the economy is slowing, however, is something different occurring today that is causing this disconnect? We think so and it has to do with too much supply and not a reduction in demand. So back to the recession question. Below are a few economic variables which we believe tilt towards a growing economy, albeit a slow growth one.

Indicators exhibiting a positive trend:
  • Jobless Claims
  • Consumer Confidence
  • Existing Home Sales
  • Retail Sales
  • Interest Rate Spread (the TED spread)
The three indicators showing weakness:
  • Durable Goods Order
  • Industrial Production
  • ISM Purchasing Managers Index (Manufactures Survey)
    Jobless Claims
    • Continued improvement is seen in the 4-week moving average of initial jobless claims with the latest reading reported at 283,000. Additionally, the Job Opening Level (red line) continues to move higher and is far above the level prior to the last recession.
    From The Blog of HORAN Capital Advisors

    Existing Home Sales
    • In December the National Association of Realtors reported a 14.7% seasonally adjusted annual rate of growth in existing home sales. This puts the number of units at 5.46 million for December versus the annual rate of 4.76 million in November. The median home price rose 7.6% in December 2015 versus the same period in 2014. One factor contributing to sale price increases is the low level of homes for sale. Potential headwinds to home sales in 2016 is potentially higher mortgage rates as the Fed continues to move interest rates higher and a weak home market in areas negatively impacted by weak energy prices. 
    From The Blog of HORAN Capital Advisors

    Retail Sales and Consumer Confidence
    • For the month of December 2015, retail sales did decline .10% versus November. For the fourth quarter of last year, retail sales were up 1.8% versus the same time period in 2014. Included in the below chart with retail sales is consumer confidence and the trend in confidence continues its upward trajectory. With the decline in energy prices and a strong confidence level, retail spending is likely to maintain its upward trend. The economy is unlikely to dip into recession when consumer confidence continues to exhibit strength.

    From The Blog of HORAN Capital Advisors

    TED Spread
    • The TED Spread is the difference between the yield for 3-mo Treasury Bills and 3-mo Libor. The spread represents the premium investors require to lend money to a bank rather than to the U.S. Treasury. The spread has remained below 50 basis points since early 2012. The spread spiked above 50 in January 2012 on the back of the gridlock in Washington D.C. surrounding the debt ceiling debate and the eurozone crisis that involved Greece. The current spread is elevated and worth watching; however, readings below 50 are indicative of an environment where credit risk among counterparties is not increasing.

    From The Blog of HORAN Capital Advisors

    Durable Goods
    • As reported by the U.S. Census Bureau, new orders for manufactured durable goods in December declined 5.1%.
    • The decrease, down four of the last five months, followed a 0.5 percent November decrease.
    • Excluding transportation, new orders decreased 1.2%.
    • Excluding defense, new orders decreased 2.9%. Transportation equipment, also down four of the last five months, led the decrease, down 12.4%.

    From The Blog of HORAN Capital Advisors

    Industrial Production and ISM Purchasing Managers Index
    • In December Industrial Production declined .4% and was centered in weakness in utilities and mining. The weakness in the utilities sector is the direct result of a warmer winter across parts of the U.S. Weakness in mining reflected lower commodity prices and contraction in energy extraction,
    • Weakness in the ISM Manufacturing Index was centered in the decline in employment by 2.1 points. The one positive from the report was the increase in new orders which came in at 51.5.

    From The Blog of HORAN Capital Advisors

    From The Blog of HORAN Capital Advisors

    The bright spot in these last two surveys is the fact the non-manufacturing survey continues to show strength as seen in the above chart. As reported by Econoday, "There may be export-related weakness in the manufacturing sector but it has yet to spill over to the overall economy. ISM's non-manufacturing index did slow 6 tenths to 55.3 in December but the level is still very solid and details are positive. New orders are up 7 tenths to a very strong 58.2 while employment is also up 7 tenths, to 55.7. The sample is building up inventories which hints at expectations for solid business ahead. Another positive is the export index which, like the ISM manufacturing report issued Monday, bounced solidly higher and back into the plus-50 growth column, at 53.5. Input prices show very little change. This report continues to be consistent and solid, underscoring the strength of the nation's domestic-based economy."

    In conclusion, the weaker aspects of the economy appear to be centered in the manufacturing sector and the energy sector. Importantly, the U.S. is a consumer led economy where manufacturing represents 12-14% and consumer and services represent the other 85%. The energy weakness is one were too much supply is straining companies with direct or indirect energy exposure. This growth in oil supply (green line) is evident in the below chart which was included in yesterday's post.

    From The Blog of HORAN Capital Advisors

    Aside from the marginal energy producers going out of business, a supply cut seems necessary to correct the demand/supply imbalance. Countries with state owned oil operations should be the most highly motivated to curtail supply. As the below chart indicates, many of these countries require oil prices that are significantly higher than where oil is trading today in order to balance their budgets. The risk these countries are facing beyound running out savings, is the potential to push the global economy into recession. In that situation demand declines and supply becomes an ever larger overhang. Oil could easily trade in the mid to low teens per barrel if this were to occur. We do not see a recession at the moment given the benefit lower energy prices have on the consumer segment of the economy.


    From The Blog of HORAN Capital Advisors


    Sunday, January 31, 2016

    Understanding The Disconnect In The Correlation Between Oil And Stock Prices

    Recently a number of commentators on the weekly business shows have commented oil prices and the stock market have been moving in the same direction during the month of January. On the few days oil and stocks moved in opposite directions, the conclusion was this would be a good thing for the overall market. Not wanting to single out any one specfic strategist, but this past Monday, Bill Stone, chief investment strategist at PNC Wealth Management, noted on CNBC, "it's not clear whether the selling will subside for now because of the tight correlation between stocks and oil prices, which he says should break at some point (emphasis added)." This comment is similar to a number of other strategists.

    So what is the point then? As the below chart shows, going back to the mid 1980's the price of oil and the price of stocks have a positive correlation of .66. It only has been since October of 2013 that this correlation broke down and reversed. Since the October 2013 time period, the correlation between oil prices and stock prices has been a negative .74. In other words, market participants should be rooting for higher oil prices and a return to the positive correlation that has been evident over the long run. In all seriousness though, investors should be aware of the fact that there is a high positive correlation between oil and stock price movements.

    From The Blog of HORAN Capital Advisors

    A number of factors can influence the price of oil, but stronger demand in an environment of stable supply can cause oil prices to rise. This often occurs when stronger economic activity is present. What seems to be occurring today is lower oil prices face downward pressure due to the continued increase in supply in spite of a significant reduction in drilling rig count. The first chart below shows global demand has continued to increase; however, supply growth is greater than the growth in demand. The supply/demand imbalance does not come into balance until late 2016. The second chart shows rig count (maroon line) has declined by more than 60%, i.e., 1,216 rigs, yet supply (green line) has continued to grow.

    From The Blog of HORAN Capital Advisors

    From The Blog of HORAN Capital Advisors

    In conclusion, we believe the recent disconnect in the movement between stock and oil prices is influenced more by excess supply and not a decline in demand. The positive to draw from this one data point is economic activity is not contracting if one evaluates the oil consumption part of the economy. If lower oil prices continue to be realized, at least in the first half of this year, this should be a tailwind that supports consumer spending in other areas besides energy and supports steady economic growth this year.


    Sunday, January 24, 2016

    Sentiment Supportive Of Further Equity Gains

    Two Fridays ago (1/15/2016) I highlighted sentiment readings often associated with an oversold equity market. Two days later, Wednesday of this past week, the S&P 500 index bottomed and staged a turnaround, generating its first weekly gain of the year, up 1.4%. A number of the sentiment measures improved with this turnaround, yet two positive return days does not qualify as a new bull market. Below is a table consisting of a number of sentiment indicators comparing readings from two weeks ago to the just concluded week.

    From The Blog of HORAN Capital Advisors

    The equity put/call ratio, the Vix and the Vix/10-year Treasury Yield ratio improved. Although improvement was seen in the P/C ratio, the 21-day moving average of the ratio moved higher to .79 versus last week's average level of .76 as can be seen in the below chart. A sustained move lower in this average is associated with increasing equity prices. With the elevated level of this average, a turn lower is a high probability.

    From The Blog of HORAN Capital Advisors

    One recent concern for investors is the spike in volatility experienced by the market. A part of the heightened awareness has been the lack of downside volatility from 2011 until the August 2015 correction. Since 2011 the Vix index has traded at a lower average level of 15.80 compared to the time period from 1995-2011 when the average was 20.96. As noted in several earlier blog posts, the Vix index is a measure of implied equity volatility. Higher levels in the Vix imply a higher level of market uncertainty or fear.

    From The Blog of HORAN Capital Advisors

    In an effort to compare the Vix to economic expectations, one can evaluate the Vix divided by the 10-year Treasury Yield. A number of factors can influence Treasury yields, but the perception is lower yields on longer term Treasuries are reflective of a weaker economic environment. As a result, one would want to see a lower Vix to 10-year ratio. As the table above noted, this ratio has declined over the last week.

    From The Blog of HORAN Capital Advisors

    Of importance is the fact this ratio has traded at a higher average level since 2011 at 7.49 versus 5.34 from 1995-2011. As can be seen in the Vix only chart above, the Vix has traded at a lower level since 2011. Consequently, the Vix/10 year ratio has been higher due to the lower level of the 10-year Treasury, indicating the market has been expecting a weaker economic environment. And the economy has been growing below its long term potential.

    Lastly, the NAAIM Exposure Index is trading at a level notable for oversold markets. The NAAIM Exposure Index consist of a weekly survey of NAAIM member firms who are active money managers and provide a number which represents their overall equity exposure at the market close on a specific day of the week, currently Wednesdays. Responses are tallied and averaged to provide the average long (or short) position or all NAAIM managers, as a group.

    From The Blog of HORAN Capital Advisors

    This lower equity volatility translated into the market moving higher nearly unabated since 2011. August 2015 rolls around and breaks the nearly four year streak without a greater than 10% correction as the market fell 12.4%. A market recovery took hold into year end and another correction unfolded this month.

    From The Blog of HORAN Capital Advisors

    For a number of reasons I expect the equity market to experience higher volatility going forward. The core of the Federal Reserve's quantitative easing programs has ended and the Fed has embarked on a tightening program with December's rate increase, and this is likely to cause increased market volatility, but not all to the downside. The issues impacting the energy market are also negatively weighing on the market and investor sentiment. A difference between 2008/2009 and now is the fact the 08/09 issues were related to housing and ultimately negatively impacted the consumer. With the issues facing the energy sector, the outcome has been lower oil prices and this serves as a broad benefit for consumers. As Charles Schwab recently noted in a report, it would also be the first time a sharp decline in oil prices led to a recession.

    From The Blog of HORAN Capital Advisors

    The coming week will contain potentially market moving news. The Fed has a meeting scheduled with an announcement on Wednesday, the first estimate of fourth quarter GDP is reported on Friday and 44 companies report earnings this week. A number of energy, materials and industrial firms are included in the 44 announcements and the market will look to guidance for insight into potential economic growth ahead.


    Sunday, January 17, 2016

    Ed Hyman And Dennis Stattman On Their International Outlook

    Earlier this week Consuelo Mack of WealthTrack conducted Part II  of her interview (Part I highlighted last week) with legendary economist Ed Hyman, Chairman of Evercore ISI, and Dennis Stattman, fund manager on BlackRock's Global Allocation Fund. This interview occurred after the market weakness experienced during the first week of January so both guests were aware of the early year market contraction.

    Ed Hyman believes the global issues facing economies are a result of growing too slowly and attributes this to the slowdown in China. This below potential growth rate leads to potential deflation and he cites the issues within the commodity sectors. His favored international market is Europe, but does acknowledge the benefits taking place in Japan after nearly 25 years of no growth in that country. He does believe China is the key for the broader emerging market arena and does think China's economic policies are moving in the right direction, i.e., getting growth in consumer demand and moving away from fixed asset investment. He cites good China sales data from Apple and Alibaba. His biggest worry is the issues in the Middle East as a result of the decline in oil prices and the negative impact this has on revenues for those countries.

    Dennis Stattman is a pound the table bull on Japan. He notes that earnings growth and dividend growth for Japanese firms has left price earnings ratios for Japanese companies nearly unchanged. He cites Japan is the only major area where earnings revisions are positive. He does worry about the debt growth in China and the slowing of GDP growth in the country. Dennis' biggest worry is China experiences a large decline in tts currency and that adjustment negatively impacts other emerging markets. He believes a world of quantitative easing, asset prices in the QE countries inflate and economies do benefit. Hedging the currency exposure is an important factor for individuals investing in Japan though.

    As with the Part I interview, this is a worthwhile viewing for readers.


    Friday, January 15, 2016

    Maximum Fear May Be Near

    To say the least it has not been a rewarding start for investors in the equity markets so far in 2016. After the volatile downside move in equities today, the S&P 500 Index closed at 1,880, down 8% year to date. Intraday today the S&P 500 Index was down 3.3% and pierced the August low of 1,867 and finally closed down 2.1%. The market action has raised the investor fear level to near oversold levels, if not to a maximum oversold level.

    The equity put/call (P/C) ratio spiked above 1.0 to 1.14. As I have noted in earlier posts, P/C ratios above 1.0 are representative of an oversold market. 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 by the individual investor.

    From The Blog of HORAN Capital Advisors

    A week ago I wrote about the VIX futures curve being in backwardation. Steeper backwardation has occurred after the market action today. Backwardaion took place near the market bottom on August 25, 2015. VIX backwardation is an indication traders expect volatility in the future to be lower than it is now. Historically, when this occurs, short term market rallies tend to result from this technical event.

    From The Blog of HORAN Capital Advisors

    Further, individual investor bullish sentiment fell four percentage points to 17.9% as reported by the American Association of Individual Investors earlier this week. The last time the reading was near this level was April 14, 2005 when bullish sentiment was reported at 16.5 and the S&P 500 Index was trading at 1,173. Investor sentiment is a contrarian indicator and this level of market pessimism is another sentiment measure that may mark another interim market bottom.

    From The Blog of HORAN Capital Advisors

    Scott Grannis, writer of the Calafia Beach Pundit blog and former Chief Economist at Western Asset Management, highlights other fear measures that readers may find useful in reviewing. His recent post includes commentary on the stress in the bond market and notes the higher liquidity in the markets today versus in 2008. As with most market sell offs, elevated fear levels are the fuel to the fire, yet can result in a market that becomes too oversold.


    Wednesday, January 13, 2016

    The Clarion Call On The Market

    On Tuesday The Royal Bank of Scotland's credit chief, Andrew Roberts, made the clarion call to 'sell everything.' He predicts a cataclysmic year faces investors in 2016. A day earlier, a J.P Morgan equity strategist advised investors to sell any rally.

    Investors are grappling with an increase in market volatility at the start of the New Year. After celebrating the end of a flat to mostly negative year in 2015, investors least expected the pace of the current January market pullback. As I discussed in this past weekend's post, A Difficult Beginning For The Market To Start The New Year, market swings of greater than 10% have been scarce since 2011. Essentially, the market steadily climbed higher for nearly four years until last August when the S&P 500 Index declined 12.4% from the May high. In other words, investors may have been conditioned to expect lower volatility from stock prices.

    Earlier today, Alan Steel, Chairman of Alan Steel Asset Management, a Scotland-based investment firm, wrote the below succinct commentary about the current market environment and the accuracy of strategists' doomsday market predictions:


    Tuesday, January 12, 2016

    Winter 2015 Investor Letter: Narrow Leadership And Heightened Volatility


    In our recently published Winter 2015 Investor Letter we discuss the challenging year faced by investors in 2015. A number of notable events occurred in 2015, the market succumbed to a 10% correction after going nearly four years without one, the Federal Reserve raised interest rates for the first time in over nine years, and 2015 equity market returns were concentrated in a handful of names, those names have been referred to as the FANG stocks, Facebook, Amazon, Netflix and Google (now called Alphabet.) Our Investor Letter contains our thoughts on the coming year. These thoughts include commentary on oil, the US Dollar and recent economic activity.

    From The Blog of HORAN Capital Advisors

    For additional insight into our views for the market and economy, see our Investor Letter accessible at the below link.


    Sunday, January 10, 2016

    Ed Hyman: Halfway Through Current Expansion Cycle

    Ed Hyman, Chairman of Evercore ISI, and rated the number one economist for 35 consecutive years by Institutional Investor, recently sat for Part One of a two part interview with Conseulo Mack of WealthTrack, which was aired a few days ago. Also participating in the interview was Dennis Stattman, the Portfolio Manager of Blackrock Global Allocation Fund.

    Hyman pointed out many positives he has witnessed in his travels around the country and gleaned from Evercore ISI's business surveys. In short, Ed Hyman believes the U.S. economy is only halfway through its current expansion. He believes the consumer, employment and now broadly rising wages are some factors that continue to support slow but steady U.S. economic growth. The interview does point out his concerns as well.

    Dennis Stattman on the other hand, believes greater opportunities for investors can be found in non-U.S. markets. His concern is the U.S. economy and market growth have been largely supported by the Fed's quantitative easing programs. The U.S. market began to stumble last year once the Fed pulled back on its QE endeavors. Additionally, Dennis Stattman believes U.S. firms will find it difficult to grow profits in an environment where corporate profits as a percentage of GDP are at historically high levels. Dennis did not say this, but if one believes QE inflated U.S. equity prices, the European Central Bank and Bank of Japan continue to implement QE strategies.

    The interview runs about 30 minutes and is a worthwhile viewing for readers. I will post Part Two when available, likely next weekend.