Saturday, April 19, 2014

Dow Dogs Are Front Of The Pack

Interestingly, we last highlighted the Dogs of the Dow strategy about this time last year and at that time the Dow Dogs were outperforming the overall Dow Jones Industrial Average Index. For all of 2013 the Dow Dogs of last year outperformed the Dow Index as well as the S&P 500 Index. As we turn our attention to 2014, the Dogs of the Dow are again outperforming many of the broader market indices except for the utility index and the transportation index. The Dow Dog strategy consists of selecting 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 prior year. Once the ten stocks are determined, an investor would invest an equal dollar amount in each of the ten stocks and hold them for the entire year. Investors should note the strategy has generated mixed results over the years though.

Below is the year to date performance of the Dow Dogs through the market close on 4/17/2014. Below the table is a listing of the performance of a few market indices for this year as well. The year to date outperformance of this strategy is in line with the recent rotation occurring within the market from growth style equities to value style equities.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Sunday, April 13, 2014

Week Ahead Magazine: April 13, 2014

Many of the links in this week's magazine cover commentary about the recent rotation that appears to be occurring within the equity market. Additionally, several article links provide insight into important economic reports for the coming week. Lastly, earnings season for the first quarter kicks into high gear with a number of companies reporting this week and next. The link to this week's magazine is provided below.

The Downside To Chasing Prior Winning Strategies

We have discussed the potentially negative investment consequences resulting from investors projecting recent outcomes into the future, recency bias. One key for investors to keep in mind is to determine if a recent result is the beginning of a longer term trend either up or down. What is difficult in this type of assessment is trends are not of equal duration. The first chart below shows small cap stocks have outperformed large cap stocks since the end of the bursting of the technology bubble in 2002 (nearly 12 years). The second chart compares the biotechnology ETF, IBB, to the S&P 500 Index. Biotechs have been outperforming the broader market since mid 2011 (almost 3 years). As we noted in yesterday's post, biotech performance has been much weaker over the course of the past several months than the broader market. Is this the end of the biotech outperformance trend?

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

In addition to the above market segments, small cap and biotechs, trend reversals from 2013 are also evident. In a recent comment by Charlie Bilello, CMT of Pension Partners, he compares the returns of certain market segments in 2013 versus 2014. A number of the better performing market segments in 2013 have now turned out to be the weaker ones in 2014 and vice versa.

From The Blog of HORAN Capital Advisors

Simply chasing last years winners or jumping into a trend trade too late or even too early, can have negative consequences for the return of one's investment portfolio.

Saturday, April 12, 2014

The Market Beyond First Quarter 2014

Five out of the last six trading days have seen the Dow Jones Industrial Average rise or fall by more than 100 points. This type of market volatility certainly can be unsettling to investors. In addition to these 100 point plus or minus swings, is the increased commentary by some well known market strategists that are calling for a significant downturn in the market. In spite of this volatility and the rhetoric on television news shows, the S&P 500 Index is down less than 4% from its high and only down 1.8% year to date.

The cause of the bearish market view is partly attributable to the correction occurring in some parts of the market. As the below chart shows, two sub-sectors of the market that have corrected significantly are the biotechnology companies (IBB) and the social media stocks (SOCL). A couple of the safehaven sectors, utilities and consumer staples, have held up well since the two momentum sectors below began to correct beginning in late February.

From The Blog of HORAN Capital Advisors

So, in reality, investors have found a reason to rotate out of the momentum sectors. From a positive perspective, this has brought the valuations of some of the momentum stocks back down to a more reasonable level.

Another area of the market being impacted by this rotation is the rotation out of growth type stocks to value stocks. We discussed this in an article in late March, Why It Matters That Value Stocks Are Outperforming Growth Stocks. This rotation into value is continuing and is evident in the updated chart below.

From The Blog of HORAN Capital Advisors

This type of market environment provides the bears with a platform from which they can voice their bearish market point of view. Bullish investors need to pay attention and evaluate the points raised from the bears. Importantly though, the market's direction will trend in the direction of expected future earnings growth and the anticipated growth of the economy. From an earnings perspective, the first quarter of 2014 is shaping up to be a weak one. In a recent report from Factset, they note earnings are estimated to decline 1.6% in the first quarter. If this is realized, the Q1 2014 decline would be the first since earnings declined 1.0% in the third quarter of 2012 (2013 turned out to be a good one for S&P 500 stocks). The Factset report contains highlights from some companies that have implicated the harsh winter weather experienced in the first quarter as contributing meaningfully to weaker Q1 earnings. When companies miss earnings or lower guidance, they like to find a scapegoat that is something other than an internal operating issue--the weather is the scapegoat in Q1. However, we do believe the weather is a valid factor that has contributed to Q1 earnings weakness and may likely reverse itself in the last three quarters of 2014.

From The Blog of HORAN Capital Advisors

What is an investor to do in a market like being experienced at this point in time? One investor that is gaining a great deal of press recently is Marc Faber.  Mr. Faber is predicting that the 2014 correction will be worse than the correction experienced in 1987. My problem with his correction call is the following:
I suppose if one always calls for a correction, they will eventually be right. And if Marc Faber is finally right that a 1987 style correction is in store for the market this year, should one sit out the market now.

Below is a chart of the S&P 500 Index going back to 1986. The chart clearly shows the 1987 correction when the S&P fell over 57 points to 282. About a year and a half later (April, 1989), if an investor stayed invested in the market, they would have recovered entirely from the decline.

From The Blog of HORAN Capital Advisors

In conclusion, corrections are difficult to predict. In fact, I do not know any famous market timers. One of many keys to surviving a correction is to have an appropriate allocation in one's investment account that can fund one's lifestyle without the need to sell stocks right after a significant correction. In that regard, I recommend investors read Howard Marks recent newsletter, Dare to Be Great. A few highlights from his report:
  • How do you think about risk? Is it volatility or the probability of permanent loss? Can it be predicted and quantified a priori? What’s the best way to manage it?
  • How reliably do you believe a disciplined process will produce the desired results? That is, how do you view the question of determinism versus randomness?
  • Most importantly for the purposes of this memo, how will you define success, and what risks will you take to achieve it? In short, in trying to be right, are you willing to bear the inescapable risk of being wrong?
  • The real question is whether you dare to do the things that are necessary in order to be great. Are you willing to be different, and are you willing to be wrong? In order to have a chance at great results, you have to be open to being both.

Thursday, April 10, 2014

Bullish Sentiment Reading A Positive Data Point For Stocks

This morning the American Association of Individual Investors reported individual bullish investor sentiment decline 6.9 percentage points to 28.5%. This compares to the February 6, 2014 level when bullish sentiment was reported at 27.9%. All of the decline in bullish showed up in the bearishness reading that rose 7.3% to 34.1%. The 8-week moving average of the bullishness reading declined to 36.9% and is the lowest level since this average was reported at 35.8% in mid July of 2013. For investors, this measure is a contrarian one and is most accurate at its extreme. This week's lower bullishness level is one that is approaching an extreme and in and of itself is one a positive reading for the future direction of the equity market if one is a bull.

From The Blog of HORAN Capital Advisors

Monday, April 07, 2014

Week Ahead Magazine: April 6, 2014

In spite of the weak finish to the market on Friday, most U.S. equity indices ended higher on the week. The Dow Jones Industrial Average and the S&P 500 Index finished the week up .5% and .4%, respectfully. The NASDAQ though declined 1.2% as many momentum related stocks experienced the brunt of the sell off. Economic data is pretty light this week with FOMC minutes being released on Wednesday, jobless claims on Thursday and PPI and consumer sentiment on Friday. One article in this week's magazine notes forward four quarter earning estimates for the S&P 500 Index are rising. Additionally, one of our articles notes the low bar that has been set for earnings in the first quarter. If earnings are accelerating and we start seeing a number of earnings beats for S&P 500 companies the market could be setting itself up for a rebound.

At a recent market seminar, Ned Davis Research provided a sentiment trading chart that notes trading sentiment has moved into the extreme pessimism zone. Certainly there are seasonal hurdles to overcome as we are nearing a potentially weak market period that has occurred during mid term election cycles. Below is the link to this week's magazine.

Sunday, April 06, 2014

The Labor Force Participation Rate: Now A Controversial Variable

If there is one seemingly boring economic statistic that is now creating a lot of controversy it is the continuing decline in the labor force participation rate. Much of the debate around this statistic is important because it provides insight into the health of the economy and more importantly the labor market. As can be seen in the below chart, the participation rate (maroon line) is now at a level reached in 1978.

From The Blog of HORAN Capital Advisors

I surmise if we could go back to 2007 and rewrite history so the financial crisis and resulting recession never occurred as well as no quantitative easing programs, the labor force participation rate would not be on many economists and non-economists radar. However, the angst this statistic can cause spiked last week when the Wall Street Journal reported on Friday's Employment Situation report, U.S. Reaches a Milestone on Lost Jobs. One factor in the report that stimulated some interest was the below chart that is included in the WSJ article.

From The Blog of HORAN Capital Advisors

In a response to the article, Bill McBride author of the well written Calculated Risk website, wrote an article indicating the Journal needed to post a correction to its article. The main point made in the Calculated Risk article is the Wall Street Journal's above graph ignores the demographic impact on the participation rate. Bill's article, WSJ Employment Graph ignores Demographics, Needs Correction, provides his viewpoint on the Journal's take on the payroll report.

In an article written in Investor's Business Daily, Hold The Champagne On That Job Report, this article notes the labor force has grown by 12.2 million participants. The IBD article uses the current labor force participation rate and notes, "That means just to get back to where we were when the recession started — based on a labor force participation rate of 63.2% — we have to create at least 8 million more private-sector jobs. Even if the workforce didn't grow at all, it would take us more than 3 1/2 years."

James Bullard, Chief Executive Office of the Federal Reserve Bank of St. Louis, is weighing in on the participation rate decline as well. In a paper he released in the first quarter of 2014, The Rise and Fall of the Labor Force Participation in the United States, he points to the heightened interest being placed on this indicator.
"Labor force participation in the United States has been a controversial subject in current macroeconomic discussions...The participation rate - a measure of the number of people actively involved in labor markets - has generally been a secondary concern in macroeconomics. However, with recent sharp declines following the financial crisis and recession of 2007-2009, it has suddenly become a salient topic, and one that gets discussed even in non-economic settings."

"At its broadest level, the debate about the labor force participation rate is a debate about the nature of the U.S. economy over the 4½ years since the end of the recession in the summer of 2009. Should we characterize the economy as substantially back to normal following the very severe recession? Or, has little progress really been made, so that the economy remains far from its potential?"

"There are clear lines of argument on both sides, sometimes blurring political boundaries. Some suggest that the extraordinary policy response since the end of the recession has been largely ineffectual, perhaps citing the very flat employment-to-population ratio since 2009, and that their own suggested policy responses would have produced better outcomes...." (emphasis added)
In the Bullard paper, he notes the steady rise in the participation rate from 1980 to 2000. Subsequent to 2000 the participation rate has mostly been on a decline. He does believe demographics has played a roll in the rise and now decline of the participation rate. From the late 1940s to mid 1960s the participation rate was fairly stable at 59.1%. Additionally, economic activity was pretty good during this period of a lower participation level. In the Bullard paper he notes several studies projecting future participation rate levels. In one such study, the participation rate is expected to decline steadily, or by 15 basis points, to the year 2022. In this study, 70% of the decline is attributable to demographic factors like baby boomer retirements. Several other studies are cited in the Bullard paper, but he is clear that further work needs to be done on this topic.

Lastly, if the participation rate decline is due to demographic factors, one might expect to see changes in the number of individuals receiving social security benefits that are directly attributable to retirements. The below chart shows the annual change in individuals receiving benefit payments from social security strictly as a result of retirement. For the four years from 2009 to 2012, a net of over four million individuals joined the social security system due to retirement. The below chart is certainly on a trend that would forecast net new beneficiaries for social security in excess of one million individuals annually.

From The Blog of HORAN Capital Advisors

Certainly, more work needs to be done in the area of participation. I believe it is fairly clear though that demographic effects are having a large impact in the declining participation rate itself. However, as the IBD article referenced above notes, the labor force has grown by 12.2 million individuals since the recession began. Maybe the current 63.2% participation rate is not the appropriate long run percentage, maybe it is several percentage points lower, but the economy is still not operating at full employment. The Fed is obviously looking at the unemployment rate, which continues to slowly improve, and they may be placing less weight on the participation rate.

Friday, April 04, 2014

Dividend Payers Bounce Back In March

For the month of March the dividend payers in the S&P 500 Index regained their footing and outperformed the non payers by a full 3.75 percentage points. In spite of this outperformance by the payers in March, the payers return continues to significantly trail the non payers return on a year to date and 12-month basis.

From The Blog of HORAN Capital Advisors

For investors though, is the outperformance by the dividend payers in March another sign the market is shifting to focus more on value oriented equities versus growth equities? We discussed this potential transition in a post a week and a half ago when we discussed the significance of the recent outperformance of value stocks versus growth stocks.

The market's action today was certainly most negative for the momentum oriented stocks and biotech and social media sectors. On a year to date basis the utility sector has significantly outperformed the overall market as can be seen in the below chart. Utility stocks tend to be safe haven investments for investors due to their generally higher dividend yields.

From The Blog of HORAN Capital Advisors

We would caution investors to pay attention to stock valuations (P/Es) relative to a company's earnings growth rate (PE divided by EPS growth rate) as some of these historically value oriented stocks/sectors are trading at rich valuations and high PEG ratios.

Thursday, April 03, 2014

A Low Bar Set For First Quarter 2014 Earnings

In a recent report issued by Thomson Reuters' AlphaNow, it is noted analysts have lowered the bar for first quarter earnings. The only sector that saw an increase in earnings expectation for Q1 is the utility sector. The analyst revisions result in year over year first quarter earnings growth of only 2.1% versus the 6.5% in place at the beginning of the quarter. Not surprisingly, weather is being cited as the main culprit for the lowered expectations.

From The Blog of HORAN Capital Advisors
Source: AlphaNow

The report concludes, "As the first-quarter earnings season gets under way, it will bear watching to see whether the negative effects of the weather outweigh the positive drivers of earnings, like consumer spending and the housing market rebound." Alcoa (AA) kicks off the official Q1 earnings season on April 8th.

Sunday, March 30, 2014

Week Ahead Magazine: March 30, 2014

Monday marks the last trading day of the first quarter of 2014. The first three months of market action this year have been anything but similar to the first three months of 2013. In the first quarter last year, the S&P 500 Index returned over 10%. Before trading on Monday, the first quarter return in 2014 equals about .5%. As the below chart shows, January saw some profit taking after strong returns in 2013. The S&P 500 Index recovered the January losses in February and proceeded to generate positive returns in March. However, as the below chart shows, the market is near breakeven for the quarter.

From The Blog of HORAN Capital Advisors

A number of article links in this week's magazine highlight economic data, both in the U.S. and in the euro zone, that indicates the global economic environment has stabilized and is growing moderately. 

Below is the link to this week's magazine.

Thursday, March 27, 2014

Equity Market Declines, Bullish Investor Sentiment Declines

Recently, changes in investor equity market sentiment have followed changes in the S&P 500 Index. As the market declines, bullish investor sentiment has declined as well. True to form, bullish sentiment fell this week as reported by the Association of Individual Investors. Bullish sentiment fell over five percentage points to 31.2% versus the prior weeks level of 36.8%. The long term bullishness level is 39% and one standard deviation below this average is 29%. Consequently, this level of bullish sentiment is nearing levels seen at prior market bottoms. Readers should keep in mind this contrarian indicator is most accurate at the extremes.

From The Blog of HORAN Capital Advisors
Source: AAII