Saturday, October 03, 2015

Will The Equity Market Finish The Year In Positive Territory?

A portion of the recent equity market volatility can be attributed to the fact a number of factors seem to be at critical turning points. At top of mind seems to be the focus on the timing of the Fed's move to begin increasing/normalizing interest rates. Historically, a tightening of interest rates has led to a slowdown in economic activity. Added to this is the fact corporate profit growth is forecast to be negative as we noted in a recent post, A Few Positive Equity Market Technicals. These two issues alone, a Fed wanting to tightening and weak corporate profit growth, both are playing a part in the market's recent pullback.

Just for grins, if one were to dismiss these fundamental issues and simply look at the history of the equity market itself, are there stats that would suggest the market could finish the year in positive or negative terriory? A couple of articles over the past week addressed this issue. The first article was written by Ryan Detrick. He notes in the article,
  • "...going back to 1928, the S&P 500 has never been positive year-to-date after being down more than six percent after the third-quarter. The S&P 500 was down 6.74% after the third-quarter in 2015."
In the article, he notes the average decline through the third quarter in the 23 years the S&P 500 Index was down was a negative 16%. For this year though, he notes the three quarter decline is -6.74% and is the best starting point for for any of those years. He goes on to note, for the S&P to finish the year in positive territory, the fourth quarter return would need to equal about 7.23%. More insight can be gained by reading his article.

The second article was written by Dana Lyons. his article notes,
  • "going back 140 years, every year ending in a "5" has posted a positive return since 1875. In other words, the last 13 years ending in "5" have left stock investors "high-fiving" each other. It is likely mainly due to coincidence, with a healthy dose of positive Presidential Cycle “Year 3″ tailwind mixed in for several of the years. Nevertheless, it is a consistent and compelling track record."
From The Blog of HORAN Capital Advisors
Source: Dana Lyons

So there you have it, computer algorithms might just force the continuation of the year 5 winning streak or they might decide to force the negative year streak noted in Ryan Detrick's article. Fortunately, as noted in Ryan's article, the market is at the best starting point for negative returns through three quarters.

Friday, October 02, 2015

Bearish Sentiment Is Spreading

Since mid March the AAII bullish sentiment reading has been below its long term bullish average. As a contrarian indicator, low levels of bullish investor sentiment typically point to equity markets that are near their bottom. Keeping in mind though, this sentiment reading is most predicative at its extremes. Earlier this week, the AAII bullish reading declined 4 percentage points to 28.1% and the bearishness reading jumped 11 percentage points to 39.9. The bullishness level is now more than one standard deviation below its long run average.

From The Blog of HORAN Capital Advisors
Data Source: AAII

In addition to a low level of bullishness for individual investors, the recent release of the NAAIM Exposure Index declined to 16.39%, down from 21.34% in the prior week. The NAAIM Exposure Index represents the average exposure to US Equity markets reported by NAAIM members. NAAIM member firms who are active money managers are asked each week to 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. As noted in the below chart, low NAAIM Exposure Index levels have generally coincided with equity market turning points.

From The Blog of HORAN Capital Advisors

These various sentiment measures seem to be coming together at the same time to indicate a bearish view of the markets. Since these sentiment readings are contrarian ones, possibly the market is nearing a turning point with stronger returns through the fourth quarter. As we have noted numerous times in prior posts, sentiment measures alone must be evaluated in the context of other market and economic fundamentals.

Thursday, October 01, 2015

Buyback Strategy Continues To Lag Broader Market Return

Although S&P Dow Jones Indices reported second quarter 2015 buybacks declined 8.7% versus the first quarter of 2015, the twelve month total increased 3.8% versus the prior twelve month total that ended June 2014. As the below chart shows, this reduction in buybacks on a quarter over quarter basis might be tied to the declining trend developing in as reported earnings (blue line.) In spite of the declining trend in operating earnings, Howard Silverblatt notes, "company cash reserves increased to $1.32 trillion versus the first quarter total of $1.23 trillion." Also, Silverblatt noted in the S&P report,
"Higher levels of shareholder return are now part of the market expectation, with many investors anticipating continued high payouts. While companies currently have the resources and low-cost access to funds to continue this trend, once interest rates increase, the higher costs will eventually influence the decision making process for corporate expenditures. Buybacks may be more susceptible to an interest rate hike, given that they are more discretionary and dividend cutbacks are typically seen as a last resort action. Based on the current data, the Q3 actual dividend payment is expected to be the sixth consecutive quarter of new record payments, with Q4 2015 expected to be the seventh."
From The Blog of HORAN Capital Advisors

It may simply be a spurious relationship, but the buyback index return began to trail the broader market return since the beginning of the first quarter. This can be seen in the below chart comparing the S&P 500 Index to the Powershares Buyback Index (PKW).

From The Blog of HORAN Capital Advisors

Given the decline in equity prices since the market peaked in late May, companies would benefit from increasing buybacks with their share prices at these lower levels. Unfortunately, companies have a tendency to increase buybacks when their shares are near highs. If buybacks do slow in the coming quarters, this will likely be a headwind for an already weak near term earnings growth picture.

Saturday, September 26, 2015

A Few Positive Equity Market Technicals

The equity markets have been anything but kind to investors long stocks. Nearly all the broad market equity indices are in negative territory for the year. The S&P 500 Index: -6.2%, Dow Jones Industrial Average: -8.5%, S&P MidCap Index: -4.4% and the S&P SmallCap Index: -4.6%. Simply reviewing social media comments from investors, one could be lead to believe the market has no where to go but down. Admittedly, the market trend and direction of least resistance does seem to favor the bears; however, some technical data is beginning to potentially signal a turn to a more bullish posture.

In August when the S&P 500 Index dropped to 1,867 the CBOE Equity Put/Call Ratio spiked to over 1.0 indicating a potentially oversold market. The market did recover from that August low, but recently has resumed its downtrend. Sometimes a better indicator is to look at the 21-day moving average of the put/call ratio. As can be seen in the below chart, the moving average of this ratio has begun to trend lower after reaching a high of .79 on 9/18/2015. Declines in this ratio are generally associated with a market that trends higher on a go forward basis.

From The Blog of HORAN Capital Advisors

Friday, September 18, 2015

The Fed Is In A Pretty Tight Corner On Future Of Rates

So the Fed did not raise rates yesterday. To some this seemed to be a surprise; however, as we noted in our post a few days prior to the announcement we believed global economic factors could play a part in the Fed's rate decision. In fact, Janet Yellen cited issues in markets outside the U.S. as one reason for not moving on rates. Additionally, inflation in the U.S. remains well below the Fed's 2% target rate. Possibly the biggest surprise out of the meeting was the fact one Fed member believes the Fed needs to move to a negative interest rate position.

In our view the Fed has waited too long to move interest rates higher. The result is the Fed is now in a position where their next move, not necessarily in the next six months, would be lowering rates given where both the U.S. and global economies are in their respective business cycles. The comment on negative interest rates by one Fed member was likely not made without the blessing of Yellen in advance of the meeting. Because the Fed may believe they missed the opportunity to raise rates, the negative interest rate comment is a way to telegraph to the market they have a tool to stimulate if necessary in spite of the current zero interest rate level.

From The Blog of HORAN Capital Advisors

The other factor at play in the Fed's decision maybe the interplay of higher rates and currency exchange rates. It is clear that China and Russia have been selling Treasuries in an effort to weaken support their own currencies.  (updated: 8:30pm)

Wednesday, September 16, 2015

Fed Rate Decision More About The Economy Than The Rate Itself

Probably the most discussed potential Fed decision on rates is the one forthcoming on Thursday. When it is all said and done, the rate increase in and of itself is really not the issue investors should factor into their investment decision. As we have pointed out in prior posts, higher rates have mostly been a positive for stock returns. A primary issue is the state of the economy, both in the U.S. and globally and the tightening impact of a rate increase. Compounding the confusion around the impending rate increase or no increase, is the uncharted territory created by all of the Fed's quantitative easing activities implemented since the end of the financial crisis.

In reality, a quarter percent (25 basis points) increase from a near zero rate is likely to have no material impact on many fronts. The pace at which the tightening is pursued though is an issue. The other is the fact the Fed states rate decisions will be data dependent going forward. Therein lies the market's confusion. The Fed has a 2% inflation target which has yet to be reached and it is debatable if the economy is near full employment given the sharp decline in the participation rate. A case can be made that the last QE program was not needed and a tightening cycle should have been started over a year ago. In reality, at the end of QE3 the Fed made clear it would retain bonds purchased under the QE programs, would also reinvest bond proceeds and rates would remain near zero for a "considerable time." All of these are easing activities. This brings us to the decision on Thursday and the data that outlines economic activity.

Saturday, September 12, 2015

A Potentially Weakening Consumer And The Fed's Predicament

One aspect of the market's recovery since the financial crisis has been the strength of the consumer discretionary sector. Within the sector itself the retail industry group has outperformed both the S&P 500 Index and the overall discretionary sector itself. This strength could not occur over this long of a period without an improving consumer. The second frame in the below chart, however, shows the retail ETF has begun to underperform the discretionary sector this year and is a potential sign of a weakening consumer.

From The Blog of HORAN Capital Advisors

This weakness in the retail sector is further confirmed by the very poor University of Michigan Consumer Sentiment Index preliminary results reported on Friday. The sentiment reading of 85.7 was over six points lower than the August reading of  91.9 and below the low end estimate of 86.5. Econoday's summary of this report indicates this may put a potential Fed rate hike on hold later this month.
"Just when you think you've gotten through the week, consumer sentiment dives and, perhaps, tips the balance against a rate hike. The mid-month September flash for the consumer sentiment index is down more than 6 points to 85.7 which is below Econoday's low-end forecast. The index is now at its lowest point since September last year.

Weakness is centered in the expectations component which is down more than 7 points to 76.4, also the lowest reading since last September. Weakness in this component points to a downgrade for the outlook on jobs and income. The current conditions component also fell, down nearly 5 points to 100.3 for its weakest reading since October. Weakness here points to weakness for September consumer spending. Inflation readings are quiet but did tick 1 tenth higher for both the 1-year outlook, at 2.9 percent, and the 5-year, at 2.8 percent.

New York Fed President William Dudley himself has said he is focused on this report as an early indication of how U.S. consumers are responding to Chinese-based market turbulence. These results offer a rallying cry for the doves at next week's FOMC meeting."

From The Blog of HORAN Capital Advisors

The above chart also includes retail and business inventory to sales ratios. The business inventory to sales ratio (blue line) is far above the pre-2008 recession level and near the recession level prior to 2001. Also, the retail I/S ratio is near the levels reported in 2008. As noted above, the expectations and current conditions components of the sentiment report suggest weakness in the months ahead.

Consumer sentiment is not the only driving force of economic growth; however, the consumer does account for 70% of economic activity. The poor sentiment report does provide some Fed members with data that suggests a Fed hike should not occur this month. The Fed is in a corner for sure as we have noted in several recent blog posts. They seem to have missed an opportunity to raise rates a year or more ago. We will see if they raise them now in spite of the continued slow growth economy and a potentially weakening one.

Thursday, September 10, 2015

Bullish Technicals Forming In The Midst Of The Correction

As is typically the case when the market is attempting to form a bottom, positive technical signs can be difficult to uncover in the midst of the bearish chatter. This time seems to be no different and the key is whether potentially positive technicals can win out in the face of some weakening fundamental factors.

The below chart shows the daily price action for the S&P 500 Index along with several technical indicators. Although the MACD  indicator line has not crossed the signal line, the MACD line (green) is nearing that cross. Additionally, the stochastic oscillator made new highs in August at a time the market was selling off. Shortly thereafter the stochastic oscillator fell below 20 on the gap lower low. Subsequent to this oversold indication, the market moved higher. Of interest in the below chart is the symmetrical pennant pattern that has formed with the market's higher lows and lower highs. A break above resistance will be important for further market upside.

From The Blog of HORAN Capital Advisors

Sometimes changing the exponential moving average settings for the stochastic oscillator can provide a clearer picture of the action in the market. The below chart uses a (5,21,5) setup. As can be seen below, this set up also shows strengthening upside momentum.

From The Blog of HORAN Capital Advisors

Investor sentiment measures are at extreme bearish levels as well. Yesterday, Pension Partners noted the Investors Intelligence Sentiment of the percentage of bulls was at its lowest level since the October 2008 reading of 22.2%.

From The Blog of HORAN Capital Advisors

Lastly, the 21-day moving average of the equity put/call ratio is at its highest level since late 2011. The equity put/call ratio is also indicating overly bearish sentiment and at this level the market has a history of moving higher.

From The Blog of HORAN Capital Advisors

In short, the market correction seems to be attempting to form a bottom. Of particular interest will be watching how the pennant pattern is resolved that is noted in the first chart above. A break above resistance would be an important market inflection point. With the increased influence of algorithmic trading, short term trading within the pennant is a high probability. And the market's uncertainty around whether the Fed raises rates or not this month has many investors on the sidelines until this event is resolved. In the end, some positive technical setups are forming in the face of this uncertainty that could enable the market to move higher into year end.

Saturday, September 05, 2015

Market Timing Risk

Market timing, i. e., when attempting to trade into our out of the market, is a difficult strategy for nearly all investors. A Barron's article written in October of last year, The Timeless Allure of Stock-Market Timers, highlighted a few strategists' ill-timed calls and their confusion on why it did not work. The worst part of market timing is the fact the timing of getting out tends to occur near market bottoms and then getting back in the market near market tops.

Making ill-conceived market moves can reduce the growth of one's investments substantially. The below chart graphs the growth of the S&P 500 Index from 1990 through June 30, 2015. The blue line displays the growth of $10,000 that remains fully invested in the S&P 500 Index over the entire time period. The yellow line shows the same growth, but excludes the top 10 return days over the 25 year period (6,300 trading days.) By missing the top 10 return days over the 25 year period, the end period value grows to only half the value of the blue line that represents remaining fully invested.

From The Blog of HORAN Capital Advisors
Source: ICMA-RC

Given the market's recent pullback the calls for getting out of stocks has picked up momentum. Until this most recent pullback, the S&P 500 Index had gone over 1,300 trading days without a 10+% correction. This extended run without a 10+% correction can be seen in the below chart.

From The Blog of HORAN Capital Advisors
Source: Goldman Sachs

For an investor they should not get caught up in the market timing conundrum. These sell decisions often occur near equity market bottoms. Alternatively, an investor should stick with their asset allocation plan that incorporates their time horizon and risk tolerance. If the recent market pullback is jeopardizing one's retirement as a consequence of the recent downward move in equities, they should reevaluate what an appropriate asset allocation should be. The investor's asset allocation preferences should incorporate the time horizon for various buckets of assets. Shorter term investments should not be invested in equities if accessing these funds will occur over the next several years.

Timing the market may sound appealing, especially after a pullback like we are experiencing at the moment. Reducing equity exposure when the market has become increasingly volatile will certainly relieve some anxious feelings. If near term access to investments necessitates reducing equity at the moment, be sure that is the case and equity exposure is not being reduced in an effort to simply time the market. The increased market volatility experienced over the last few months is certainly more typical of equity movements and is likely to continue in the near term.

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.