Individual Investor Bullish Sentiment Spikes Higher

Today's release of AAII's Investor Sentiment Survey saw bullish investor sentiment increase 10.5 percentage points to 49.0%. This reading is right at the average plus one standard deviation level. The bull/bear spread widen to +27.4%. The weekly reading can be volatile so looking at the 8-week moving average smooths some of this volatility. This week's 8-week average is reported at 33.7%, up from 32.3% last week.

From The Blog of HORAN Capital Advisors

Anadarko Petroleum Trades As Low As One Penny On Friday

In the final second of trading on Friday, Anadarko Petroleum Corp. (APC) goes from a $90 stock and trades down to $.01, that is a penny a share before closing at $90.03. I am sure some buyers (computers) thought they were fortunate to pick up APC at one penny. On the contrary, the NYSE canceled trades executed below $87.56 per share.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

This type of trading activity certainly weighs on investor confidence in the markets and is an issue that most certainly needs to be addressed.

Complacency Setting In And Fund Flows

As the market continues to seemingly move higher every day, investor complacency appears to be on the rise. The recent CBOE equity put/call ratio is at a low level of .50. Like other sentiment indicators, this measure tends to be more accurate at extremes. On April 20th we wrote about the elevated put/call ratio and wondered if the market was excessively bearish. Since the time of that post, the market has advanced over 7%.

From The Blog of HORAN Capital Advisors

Additionally, fixed income assets as a percentage of all mutual fund assets recently began to decline. Are investors now warming up to equities in spite of the strong advance that has occurred year to date? On the other hand, given the low level of interest rates, bond investors are having a difficult time finding fixed income assets that provide adequate yield without taking on maturity and/or credit risk. Income yielding stocks seem to be the bond investors new bond substitute.

From The Blog of HORAN Capital Advisors

Recent economic news has not been great or not as bad as economist had expected. The Empire State Manufacturing Index was below expectations, housing starts lower than expectations and industrial production lower than expectations. The employment numbers showed an improvement last week; however, it is difficult to gauge whether it is because people continue to drop out of the work force (declining participation rate) and other non favorable factors.

This is certainly a difficult point in the market cycle for investors to navigate. One thing the market does like to do is one, prove the consensus wrong and two, climb the proverbial "wall of worry."

Bond Funds And Central Banks Are Buying Equities

Morningstar recently reported the number of bond funds buying or holding stocks is at the highest level in 18 years. The below chart from Charles Schwab details data over the last ten years. Schwab/Morningstar note the percentage of bond funds holding equities has remained stable over this time period though. Nonetheless, more bond funds are buying equities in an effort to find higher yielding securities than currently available from bonds.

From The Blog of HORAN Capital Advisors

Source: Charles Schwab

In addition to bond funds jumping into dividend yielding stocks, Schwab reported the following from a survey of the central banks around the globe:

"Last month, Central Bank Publications and Royal Bank of Scotland Group Plc conducted a survey of 60 central bankers. Nearly 25% of respondents said they own stock shares or plan to buy them. The Bank of Japan, featured heavily in the news recently and holder of the world's second-largest level of reserves, said it will more than double investments in stock exchange-traded funds by 2014. The Bank of Israel bought stocks for the first time last year, and the Swiss National Bank and Czech National Bank have upped their holdings to at least 10% of reserves.

Of the 60 banks surveyed, 14 said they'd already invested in stocks or would do so within five years. In fact, this is the first time ever the question about stocks has been in this annual survey.

Behind the heightened interest in stocks are growing central-bank reserves requiring increased diversification. In US dollar terms, the four largest central banks have expanded their balance sheets to more than $13 trillion, compared to only $3 trillion 10 years ago. Most central banks have had heavy and consistent reliance on fixed-income securities, but with yields low (and falling) in many countries, keeping all reserves in fixed income risks a declining value of reserves.

However, 70% of the central banks in the survey (including the US Federal Reserve) indicated that stocks remain "beyond the pale." A few central banks, including the Fed and the Bank of England, have no mandate to purchase stocks directly.

Jim O'Neill, chairman of Goldman Sachs Asset Management, weighed in: 'I don't think people should worry about (central banks owning stocks). Frankly, it makes a huge amount of sense in a world of floating exchange rates and such incredible opportunity, why should central banks keep so much money in very short-term, liquid things when they're not going to ever need it?'"

A Tired Bull Market

Not much seems able to restrain the strength of the bull market in U.S. equities. On a year to date basis the S&P 500 Index is up 15.43%. The advance has finally drawn investors into equity mutual funds as reflected in positive equity mutual fund flows the first three months of the year.

From The Blog of HORAN Capital Advisors

The positive market results continue to keep the S&P 500 Index in a positive uptrend channel that began in the middle of November of last year. Aside from the fact company fundamentals and valuations look reasonable, at least not overvalued, higher equity prices could continue to unfold. However, we have noted in several recent posts the rotation that has occurred of late out of the more defensive sectors into the more cyclical ones.

From The Blog of HORAN Capital Advisors

Because of the significant amount of artificial stimulus being pumped into the global economy by most central banks around the world, we believe investors need to have a heightened focus on the underlying technical aspects of the market in order to gain insight into potential market turning points. No one technical indicator is the panacea that will predict the market's future direction. One indicator useful to evaluate for the market and/or individual stocks is the Money Flow Index (MFI). This index is a variation of the Relative Strength Index (RSI). The StockCharts.com website provides the following definition of MFI:

"The Money Flow Index (MFI) is an oscillator that uses both price and volume to measure buying and selling pressure. Created by Gene Quong and Avrum Soudack, MFI is also known as volume-weighted RSI. MFI starts with the typical price for each period. Money flow is positive when the typical price rises (buying pressure) and negative when the typical price declines (selling pressure). A ratio of positive and negative money flow is then plugged into an RSI formula to create an oscillator that moves between zero and one hundred. As a momentum oscillator tied to volume, the Money Flow Index (MFI) is best suited to identify reversals and price extremes with a variety of signals."

"The Money Flow Index is a rather unique indicator that combines momentum and volume with an RSI formula. RSI momentum generally favors the bulls when the indicator is above 50 and the bears when below 50. Even though MFI is considered a volume-weighted RSI, using the centerline to determine a bullish or bearish bias does not work as well. Instead, MFI is better suited to identify potential reversals with overbought/oversold levels, bullish/bearish divergences and bullish/bearish failure swings (emphasis added). As with all indicators, MFI should not be used by itself. A pure momentum oscillator, such as RSI, or pattern analysis can be combined with MFI to increase signal robustness."

As the below charts display, the weekly chart of the market and the MFI are showing divergence. A weekly time period is used in order to smooth out the potential day to day market variations. On the daily chart, the MFI trend is positive; however, the index recently rose above the overbought area of 80 on the chart. Also, market volume has been in a steady decline since late 2011 and has not picked up in spite of positive equity fund flows as noted in the first chart in this post.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

As with any indicator, no single one is the perfect market predictor. As an example, the Accumulation Distribution Line (ADL) is in a very bullish pattern and is based on the money flow concept as well. As the ADL definition notes, this indicator has given off false signals as well.

At HORAN, we do remain positive on the market, but believe some consolidation could occur and would be healthy for the performance potential through the balance of the year. Our focus has been to reduce or sell some of the holdings in the defensive sectors and build or add to positions in the more cyclically exposed sectors that have underperformed this year, and over the last year for that matter. One stock we trimmed recently was Johnson & Johnson (JNJ). We trimmed the holding for more than technical reasons, but looking at the chart with the MFI overlay, it does show some potential stock weakness ahead when looking at just the MFI.

U.S. Centric Companies Outperforming

In a recent AlphaNow report from Thomson Reuters, it shows U.S. companies that generate a majority of their revenues from the U.S. are outperforming the broader market S&P 500 Index. The report highlights that 150 companies/stocks generated at least 95% of their revenues within the USA and outperformed the S&P 500. On a 2013 year to date basis (through May 1), they note their total return beat the S&P 500: 15% vs. 12%, and 31% to 21% in the past two years.

From The Blog of HORAN Capital Advisors

The report also notes, "The three top overweights come in sectors which have all outperformed so far in 2013 (see chart) – financials (+13% overweight), telecom services (+11%) and utilities (+10%). That’s before adding in consumer discretionary (+2% overweight) which is the second best performing sector as of May 2." Of late though, much has been stated about the potential rotation underway out of these more defensive sectors and into the more cyclically oriented ones. Investors need to be on guard about chasing past returns.

From The Blog of HORAN Capital Advisors

Can Cyclicals Breakout And Provide Momentum For Higher Equity Prices?

We noted in a post a week and a half ago that the market's defensive sectors have been the main driver of the S&P 500 Index's strong performance this year. In this earlier post, Sector Rotation May Be Underway, we noted investors may be rotating out of the defensive sectors and into the more cyclical ones. In that regard, J. C.Parets of All Star Charts wrote an interesting article showing the more cyclical sectors recent strong performance vs. the staples sector is retesting resistance for the fourth time in two years. This number of retests has historically been a bullish indicator and could be for cyclicals in this now. The question is whether this rotation into cyclicals can be sustained and drive the market to further highs.

From The Blog of HORAN Capital Advisors

Source: All Star Charts

h/t: The Kirk Report

Equal Weighted S&P 500 Index Insights

Ten years ago Standard and Poor's released its Equal Weighted S&P 500 Index (EWI). Since that time a number of index firms have created equal weighted ETFs that investors are able to invest in directly. In S&P's recently released white paper, 10 Years Later: Where In The World Is Equal Weight Indexing Now?, they cover a great deal of the historical data on the equal weighted index relative to the more common market cap weighted S&P 500 Index. Due to the cap weighted nature of the S&P 500, one obvious characteristic is the EWI S&P 500 is more heavily weighted in the smaller capitalization stocks and underweighted in the large cap stocks of the S&P 500 Index. Because of this factor, S&P demonstrates the equal weighted index does have a tendency to outperform more frequently in up markets than in down markets and the EWI does carry a higher beta.

From The Blog of HORAN Capital Advisors

In addition to more frequent up market outperformance, over a longer time frame, the EW S&P 500 Index has outperformed the cap weighted S&P 500 Index.

From The Blog of HORAN Capital Advisors

Given the emergence of technology and the tech sector leading up to the technology bubble in 2000, one might believe performance differences between equal weighted and cap weighted indices is due to the differing sector weights. However, one must keep in mind the sector weighting within the EWI is determined by the number of companies that make up the overall index. As noted by S&P,

"Since 1999, the S&P 500 EWI has been consistently overweighted materials, consumer discretionary and utilities, and underweighted energy, health care and telecommunication services relative to the S&P 500. However, for other sectors the situation has varied considerably over time. In fact, even for sectors for which the S&P 500 EWI has been consistently overweight or underweight, the difference in concentration between the two indices has altered significantly.

Throughout the history, the largest change in the relative sector weights of the two indices has been in the information technology (IT) sector, mainly due to the change in the sector weights of the S&P 500 itself. During the technology bubble in the late 1990s, the IT sector weight of the S&P 500 increased to 33% in March 2000 from 13% at the start of 1998. Correspondingly, the S&P 500 EWI went from being underweight in the sector by less than 3% to being underweight by more than 20% in the same period. This has a very important implication that explains the different performance of the S&P 500 EWI relative to the S&P 500..."

S&P's paper does indicate the performance differences are more attributable to selection effects than allocation effects though.

From The Blog of HORAN Capital Advisors

A recent example of this selection impact can be seen in the below chart comparing the S&P cap weighted and equal weighted (RSP) performance relative to Apple's (AAPL) stock price performance. RSP is the Guggenhiem S&P 500 Equal Weighted ETF. Apple remains the largest holding in the cap weighted S&P 500 Index and its significant underperformance since mid November has contributed to the cap weighted index underperforming the equal weighted index.

From The Blog of HORAN Capital Advisors

For investors then, an equal weighted approach may not result in outperformance on an every year basis; however, it has proven to outperform over longer time frames. Additionally, the EWI is rebalanced on a quarterly basis, thus, leading to a strategy that results in selling high and buying low.

Source:

10 Years Later: Where In The World Is Equal Weight Indexing Now?
S & P Dow Jones Indices
By: Liyu Zeng, CFA, Director, Global Research & Design
 and Frank Luo, Ph.D, Head, Global Research & Design

Investors' Continued Search For Yield

In this low interest rate environment, investor search parameters on Google indicate investors have a propensity for dividend paying stocks at this point in time. Last week we noted in our post, Sector Rotation May Be Underway, that the defensive sectors in the S&P 500 Index generated strong outperformance versus the more cyclical sectors this year. A common characteristic of these defensive sectors is they comprise some of the better dividend yielding stocks. A caution for investors is many of the stocks within the defensive sectors are trading at historically high valuations on a price to earnings basis.

Economic Growth A Larger Influence Than Inflation For Future Stock Performance

We have written a number of articles on the impact of inflation on future bond and stock returns. Our recent article from earlier this month, Inflation And Its Influence On Investment Classes, pointed to the fact that stocks are a good hedge against higher inflation rates versus bonds. At very high levels of inflation though, commodities are the better performing asset class.

The more significant factor, however, is the growth of the economy as measured by GDP. As the below chart shows, the S&P 500 Index continues to move higher in spite of the fact the year over year change in inflation (blue line) is muted. The equity market performs at its worst when GDP (green bar) is contracting and the economy has entered a recessionary period. Earlier in April, the month over month change in the consumer price index was reported at minus .2%. This negative CPI report had some strategist indicating the weaker equity returns for the week of 4/15 was partially due to a deflationary scare.

From The Blog of HORAN Capital Advisors

For investors then, paying attention to economic variables that might indicate a recession is forthcoming is of greater importance than inflation in and of itself. Some of the variables to watch are: jobless claims, durable goods orders, retail sales, existing home sales, consumer confidence and the interest rate spread. We touched on these data points in an article a few years back, Economic Indicators That May Signal A Bottom In The Economy, when we were looking for an economic upturn.

Sector Rotation May Be Underway

One aspect of the strong performance for the S&P 500 Index so far this year has been the outperformance of the defensive market sectors. As the below chart details, the top performing sectors this year are health care (20.5%), utilities (18.8%), consumer staples (17.8%) and telecommunications (15.3%). A notable characteristic of the defensive sectors is their higher dividend yields. With the near zero interest rate environment being perpetuated by the Federal Reserve, investors seem to be allocating some of their investment dollars to these higher yielding stocks and sectors.

From The Blog of HORAN Capital Advisors

Last week though saw a shift in which sectors were contributing to the market moving higher. As the below chart shows, the previously mentioned sectors that contributed to the positive market move on YTD basis were the worst performing sectors last week. Telecommunications, consumer staples, health care and utilities all were the worst performers. The more cyclically sensitive sectors performed the best: financials, materials, technology and industrials.

From The Blog of HORAN Capital Advisors

A characteristic of the defensive sectors at this point in time is they are trading at higher P/E multiples relative to the S&P 500 Index. The utilities, staples and health care sectors are each trading at multiples of near twenty times earnings or higher.

From The Blog of HORAN Capital Advisors

For investors, keep in mind that stocks/sectors will trade on future earnings growth prospects. Factset's earnings summary report released on Friday does show the sectors with the best anticipated earnings growth in 2014 are the more cyclically exposed sectors and not the defensive sectors that have worked so well for investors this year.

From The Blog of HORAN Capital Advisors