Thursday, September 03, 2015

Rising Interest Rates Historically A Positive For Equity Returns

The upcoming two day Federal Reserve meeting that concludes September 17th seems to have investors on edge. The million dollar questions is whether the Fed will raise rates or not. If one is a stock investor, they should hope the Fed raises rates and puts this extended anticipation to rest. Another reason investors may want to see the Fed raise rates is due to the positive impact a rate increase has on equity prices.

As we noted in a post last month, Anticipating The Rate Hike, initial Fed rate increases tend to not have a negative impact on equity prices. Further evidence can be seen in the below chart. The red dots on the S&P 500 Index chart line denote the first rate hike in a Fed tightening cycle. The yellow line represents the yield curve (30 yr treasury minus 3 month treasury bill) and one can see why investors focus on equity performance when the yield curve inverts.

From The Blog of HORAN Capital Advisors

As the red dots clearly show, the onset of a tightening cycle isn't necessarily a precursor to poor equity market performance. In our earlier article link above, we provide a magnified look at equity market performance around this initial rate hike period. Equities do tend to exhibit weakness initially; however, the weakness tends to be short lived.

S&P Dow Jones Indices recently released a report, What Rising Rates Will Not Do, that also examined equity returns in rising interest rate environments. The below chart included in the report shows the S&P 500 Index return during rising rate periods. The shaded area represents rising 10 year yields and clearly a rising 10-year treasury yield has not been a negative for stock returns.

From The Blog of HORAN Capital Advisors

Breaking down returns by month, S&P notes,
"Furthermore, between January 1991 and June 2015, the average monthly return for the S&P 500 was 0.88%. Paradoxically, in the four periods of rising rates, the average monthly return was 1.26%, compared with an average monthly return of 0.73% for the periods of declining rates. Rising rates have clearly not been bad for stocks over the past two decades (emphasis added.)"
For more insight into equity returns during these tightening cycles, our article a few years back, Rising Interest Rates Can Be Good For Stocks, provides a table outlining equity returns over various cycles going back to 1973. It seems the Fed has missed an opportunity to increase rates as far back as a year ago; however, a lift off in September doesn't mean stocks are a poor investment over a complete tightening rate cycle. Certainly, stocks are likely to experience more volatility around this initial lift off period, but can move higher after the beginning of the rate increase cycle.

Wednesday, September 02, 2015

Death Cross More Of A Buy Signal?

With the recent weakness in the equity markets, many stocks' and stock indices' chart patterns have traced out a death cross pattern in their moving averages. The Death Cross is a technical indication when the 50 day moving average crosses the 200 day moving average from above. As Michael Batnick of The Irrelevant Investor blog noted a few days ago, very few technical analyst use the death cross pattern in their chart analysis. However, much has been written about the death cross recently and a closer look at the pattern reveals stocks/indexes tend to be closer to rebounding subsequent to the death cross trigger than experience further weakness.

The chart below highlights the most recent occurrence of the death cross for the S&P 500 Index other than the one just occurring late last month.The below chart covers the calendar years 2010 and 2011. The orange line on the chart is the rolling three month return for the S&P 500 Index. This line has been shifted to the left by three months and shows the forward three month return from near the date the index average triggered the death cross pattern. For example, in August 2011 when the index triggered the death cross, the subsequent three month return for the S&P 500 Index was about 13.97%. Importantly, the worst of a market's decline tended to occur and end near the point the moving averages triggered the death cross.

From The Blog of HORAN Capital Advisors

The following four charts show death cross triggers back to 1999. The times in which the market continued to weaken once the death cross pattern was triggered was closer to or during recessionary economic periods.

From The Blog of HORAN Capital Advisors

Finally, below is the chart for the late August death cross for the S&P 500 Index. Is a subsequent rebound in the index more likely?

From The Blog of HORAN Capital Advisors

Moving averages are lagging indicators by the nature of their construction. In other words, the patterns traced out in the moving averages follow the price of an index or stock. When the death cross is triggered then, it is likely most of the price decline in the index or stock has already occurred. Again, the exception is around recessionary economic periods and our current view at HORAN Capital Advisors is the U.S. economy continues its slow growth pace and does not tip into recession.

Sunday, August 30, 2015

Stocks Higher 10-Years From Now

Before the onset of the market weakness in the early part of last week and the end of the prior week, S&P Dow Jones Indices released a report highlighting rolling 10-year annualized returns for the S&P 500 Index. The report seems prompted by a response Warren Buffett made to a question on timing the market. Buffett noted he was not a market timer and simply responded, "Stocks are going to be higher, and perhaps a lot higher, 10 years from now. I am not smart enough to pick times to get in and get out."

In the report, S&P notes,
  • "Since 1947, the S&P 500’s price return was up in 72% of calendar years. Add in dividends reinvested and that batting average jumped to 80%."
  • "And if one is worried that the S&P 500 has gone too far since the conclusion of the 2007-09 mega-meltdown bear market, consider that the rolling 10-year CAGR through Q2 2015 was +7.9%, nearly 400 basis points below the long-term average."
  • "...there have been times when things didn’t work out too well for investors, but these times were few and isolated. Of the 278 quarters of rolling 10-year CAGRs from Q1 1946 through Q2 2015, only eight were negative, and they all occurred between Q4 2008 and Q3 2010."
From The Blog of HORAN Capital Advisors

The S&P report contains additional detail on sector returns going back to 1990 and investors should find the entire report a worthwhile read. One sector highlight noted in the report is the fact, "...each sector recorded very high monthly 10-year CAGR batting averages, or frequencies of positive observations, from 100% for consumer staples, energy, materials and utilities, to 79% for telecom services and 67% for financials. The S&P 500’s average was 87%."

In short, timing the market can be a difficult endeavor for many investors, Last week's heightened market volatility is an example of this, especially for those who sold out of stocks on Tuesday.


The Wisdom of Warren
S&P Dow Jones Indices
By: Sam Stovall, U.S. Equity Strategist
August 17, 2015

Thursday, August 27, 2015

Equity Market Recovering Like October 2014

On Tuesday I wrote about the bulls waiting for that elusive equity market bounce. The wait was short as the market snap back over the last two days qualifies for that bounce. Investors are likely contemplating the market's direction from here.

A "V-type" pattern seems to be forming just as the market traced out late last year. As the below chart shows, the contraction from July to October of 2014 was not as severe as the one being experienced at the moment and took longer to develop. What is interesting is the pace of this bounce back seems to be occurring just as quickly as the one last year.

From The Blog of HORAN Capital Advisors

Tuesday, August 25, 2015

Awaiting The Elusive Equity Market Bounce That Holds

The stock market bears have been calling for this current pullback for what seems like years. Now the bulls are looking for the elusive bounce that "holds" and signals another move higher in the market. After the close on Friday, I noted the oversold market conditions and a potential bounce that may follow. Three days into this potential "bounce" scenario, the market has failed to cooperate. This shows how difficult it is to time the market and find market bottoms. Nonetheless, the bears have had years predicting a correction, so for one calling a bounce for a few days (and being wrong) should be given a little leeway.

After today's trading action, with the waterfall decline near the close, much technical damage was done to the market. On the positive side, market conditions are at extreme oversold levels. As the below chart shows, the relative strength index (RSI) reached an oversold level of 16.77. The only lower level for the RSI over the past five years occurred in August 2011 when the RSI reached 16.46 and was followed by a sustained bull market run.

From The Blog of HORAN Capital Advisors

The percentage of S&P 500 stocks trading above their 50 day and 200 day moving averages continue to indicate oversold market levels as noted in the two charts below.

Monday, August 24, 2015

Bears Awaken From Worst Nightmare

With today's market close the S&P 500 Index and the Dow Jones Industrial Average both are in correction territory, down 10+%. The S&P 500 Index is down 11.15% from its closing high on 5/21/2015 and the Dow Jones Industrial Average is down 13.33% from its closing high on 5/19/2015. It is safe to say the bears have awakened from their worst nightmare as the markets moved higher, nearly unabated, for four consecutive years until this past week. It is safe to say the market is in an extreme oversold position after today's trading activity. Nearly 90% of the stocks (444 issues) that comprise the S&P 500 Index are in correction territory, i.e., down 10+% from their 52-week highs. As we noted in a post this weekend, this figure stood at 70% after Friday's close, so more technical damage was done today.

With today's close, only 8% of S&P 500 stocks are trading above their 50 day moving average as noted in the first chart below. This low percentage was last reached in August 2011 at a time the government's credit rating was lowered to AA+ from AAA by Standard & Poor's. The second chart shows the percentage of S&P 500 issues trading above their 200 day moving average and this stands at 20.8%, again near a level last reach in August 2011.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Another indication of potential excess fear in the markets is the level of the VIX Index. Today, the VIX spiked higher to 40.74. More insight into the VIX can be found in our article post from late 2011 titled, Fearful Investors.

From The Blog of HORAN Capital Advisors

As I write this post the Shanghai Index is down over 6%, while the S&P 500 Index Futures Index is up almost 2%. Yes, there are challenges in the emerging markets, but we continue to believe developed Europe and the U.S. economies can withstand the impact of weaker emerging economies. Truth be know, China's historical growth has probably been much overstated for the past year and a half and developed economies have continued to experience economic growth, albeit slow growth. Now is likely a good time to follow Warren Buffett's often repeated quote, "Be Fearful When Others Are Greedy and Greedy When Others Are Fearful." The market action over the course of the last few days may not have shaken out all the weak hands; however, some markets and stocks are now trading at fairly attractive prices and valuations. No one can predict exact market bottoms, but the markets may be near a level where the bear trap shuts.

Sunday, August 23, 2015

Nearly 70% Of S&P 500 Stocks In Correction Or Bear Market Territory

Last week's market pullback did not spare too many equities from the draw down. As of the close on Friday, 30.3% (152 issues) of S&P 500 stocks are now down greater than 20% from their 52-week highs and another 39.0% (196 issues) are down between 10% and 20% from their 52-week highs. In total nearly 70% of stocks are in correction or bear market territory. Below is a table noting this breakdown.

From The Blog of HORAN Capital Advisors

For those investors seeking to deploy cash, below is a table and link to those stocks mentioned above. Some of these stocks are rightfully down due to fundamental business issues. However, with in depth research, some of the equities may offer investors attractive entry points to begin building long equity positions.

From The Blog of HORAN Capital Advisors

Saturday, August 22, 2015

VIX Futures Curve In Backwardation, Indicative Of A Near Term Market Bounce?

With Friday's market sell off, the VIX curve went into steep backwardation at 4.56. VIX backwardation refers to the situation when the near-term VIX futures are more expensive than longer-term 3-month VIX futures (VXV). This 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. In addition to the VIX backwardation, I noted other overly bearish technical indicators in our post yesterday, Oversold Technical Indications, Market May Be Due For A Bounce. In total, these bearish sentiment levels are viewed as contrarian signals.

From The Blog of HORAN Capital Advisors

Friday, August 21, 2015

Oversold Technical Indications, Market May Be Due For A Bounce

The market action on the last two days of this week was not kind to equity investors. The Dow Jones Industrial Average closed down 530 points today and closed the week in correction territory, i.e., down 10% from its May high. The S&P 500 Index has not reached correction territory though, down 7.5% from its closing high on May 21st.

From The Blog of HORAN Capital Advisors

The pullback this week in the S&P 500 Index and the Dow has resulted in oversold market conditions that historically have resulted in a subsequent market bounce. The equity put/call ratio closed today at 1.04 and levels above one are indicative of overly bearish market sentiment.
The equity P/C ratio tends to measure the sentiment of the individual investor by dividing put volume by call volume. At the extremes, this particular measure is a contrarian one; hence, P/C ratios above 1.0 signal overly bearish sentiment from the individual investor. This indicator's average over the last 5-years is approximately .635 indicating the individual investor has been generally mostly bullish and more active on the call volume side.

From The Blog of HORAN Capital Advisors

Another indication the market is oversold is the percentage of stocks trading above their 50 and 200 day moving averages. Both of these measures show the extent of the weakness in the market. The 200 day moving average is approaching levels last reached during the fiscal cliff period/sell off in the later half of 2012.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

We noted in articles in April and May of this year that those smaller pullbacks at that time were not likely the beginning of a correction. Activity this week certainly qualifies for that correction.

The dog days of summer are now showing their colors. The question for investors is whether this pullback is one that will extend into a bear market, i.e., down 20%. This is difficult to predict; however, we do believe economic activity in the U.S. and in developed markets outside the U.S. continue to show growth, albeit slow.
  • The weakness seen in emerging markets along with their currency depreciation policies, certainly are of concern. We do not believe a full blown currency war occurs as this will benefit no country.
  • Japan's growth has fallen below expectations and this is in spite of a massive QE program being pursued by the Bank of Japan.
  • From an economic cycle perspective it has been some time that the U.S. economic cycle has been out of sync with foreign economies. The Fed wants to increase rates if for no other reason than to have fire power available if needed down the road. Many developed overseas markets, especially the euro zone, have just recently embarked on a QE strategy in an effort to stimulate growth. This will keep euro zone interest rates down at a time the Fed is trying to move our rates higher. This would result in a further strengthening of the US Dollar versus the Euro. A strengthening Dollar will continue to pressure multinational company earnings/sales.
  • The laser focus on the Fed's rate policy is also creating market uncertainty. We do not see specific economic data points that suggest the Fed should increase rates. The corner the Fed is in at the moment is the fact rates should have never been left this low for this long. The sooner the rate increase occurs, probably the better for the market looking 12-months out.
The sideways action for the markets for the better part of this year has culminated in quite a bit of technical damage to a broad basket of stocks and the indices themselves. Repairing this technical damage does not occur overnight. On the other hand, many individual stocks are in bear market territory and maybe this week's market action provides an opportunity to begin deploying excess cash. It is difficult to predict market bottoms though.

Wednesday, August 19, 2015

High Beta Underperforming Low Volatility

As the market continues to trade sideways in its, seemingly, directionless trade, it is helpful to observe various intermarket relationships and technical indicators to see what exactly is driving returns and to check-up on the overall health of the market.  One interesting dynamic of the market this year is the underperformance of high beta stocks in relation to low volatility stocks.  In a typical bull market, high beta stocks outperform as market psychology shifts to a “risk on” mindset where cyclical companies (such as high beta and high growth stocks) are favored over non-cyclical companies that provide lower, more protected exposure.  This has not been the case this year.  High beta stocks have underperformed low volatility stocks measured by the ratio of the performance of the S&P 500 High Beta ETF (SPHB) over the S&P 500 Low Volatility ETF (SPLV).   As the ratio moves higher, high beta is outperforming low volatility and as the ratio moves lower, low volatility is outperforming high beta.

From The Blog of HORAN Capital Advisors

The performance dispersion can partially be explained by the difference in sector weighting of these two ETFs.  Given SPHB's high beta, cyclical tilt, overweights in Energy and Industrials have been a big drag on performance.  Conversely, SPLV has no Energy exposure and higher weightings to Consumer Staples and Health Care, two sectors that traditionally carry lower volatility and have outperformed the broader market this year. These are a few examples of why the low volatility strategy is outperforming not only high beta names this year, but has also caught up to the S&P 500.

From The Blog of HORAN Capital Advisors

This being said, it is interesting to note that growth stocks are still outperforming value stocks in the same time period, shown by the relationship between the S&P 500 Growth ETF (IVW) and the S&P 500 Value ETF (IVE).

From The Blog of HORAN Capital Advisors

While this is not a new dynamic to this bull market,  the amplified disparity in performance since the end of June is noteworthy as investors continue to favor companies with higher growth rates in this slow, bump along environment. High beta stocks may reverse trend and outperform the low volatility strategy should the market resume a trend to new highs, but until then, low volatility is in play.