Sunday, April 19, 2015

Economic Surprise Indices: Bad News Might Actually Be Good News

One criteria investors and strategists evaluate on a regular basis is whether or not economic data that is reported on a near daily basis is exceeding or missing expectations. A commonly reviewed index is the Citigroup Economic Surprise Indices (CESI). According to Bloomberg,
"The Citigroup Economic Surprise Indices are objective and quantitative measures of economic news. They are defined as weighted historical standard deviations of data surprises (actual releases vs Bloomberg survey median). A positive reading of the Economic Surprise Index suggests that economic releases have on balance [been] beating consensus. The indices are calculated daily in a rolling three-month window. The weights of economic indicators are derived from relative high-frequency spot FX impacts of 1 standard deviation data surprises. The indices also employ a time decay function to replicate the limited memory of markets."

One takeaway from the negative level of the CESI for the U.S. is the fact economic reports have been falling short of strategist expectations. This in turn could push the Fed to act later on pushing short term interest rates higher. Also, as noted in a recent article in the Wall Street Journal, When Bad News Is Good for Stocks,
"It is important to understand, though, that the surprise index doesn’t rise or fall with the ebb and flow of the economic cycle. Because it measures a rolling average of how things turn out relative to forecasts, more often than not it tends to turn negative after there has been a streak of encouraging economic news, such as in late 2014. This is because forecasters often mistakenly extrapolate recent trends."
"When the index is deeply negative, as it is today, that is usually a good sign for stocks. Following the weakest 5% of observations since 2003, the S&P 500 rose by 14.4%, on average, during the following six months. Conversely, it rose by just 5.5% following times when the surprise index was highest."

"Today’s trough puts the index in the lowest 8% of readings. This is unusual given stocks are within spitting distance of all-time highs, despite softer-than-expected economic reports."

"The possible reason for this revolves around the Federal Reserve, which may be just months away from raising interest rates for the first time in nine years. News that is disappointing enough to sow doubt in rate setters’ minds without signaling a recession is seen as ideal for stock prices."

From The Blog of HORAN Capital Advisors

Further, the CESI for the Euro Zone has been counter to that of the U.S., that is, economic data reports have been exceeding strategists' expectations and the Euro STOXX 600 Index has responded positively. We have commented frequently with clients about the recent need to hedge the exposure to the the Euro versus the US. Dollar in order to protect returns generated in the Euro currency.

From The Blog of HORAN Capital Advisors

For investors, is this string of expectation beating reports in Europe nearing an end? We do not believe so. We are seeing corporate earnings report revisions trending more to the positive than the negative as well as continued expectation beating economic reports out of Europe. We touch on several of these points in our soon to be released Investor Letter. In a recent Bloomberg article,
"Jack Ablin, chief investment officer of BMO Private Bank in Chicago, said he pays attention to the surprise indexes as a way to gauge when a particular national economy may be turning and looks for good value in equities.
From The Blog of HORAN Capital Advisors
It is an early indication of a momentum shift," he said, "adding that he's been raising the amount of money put into international stocks. While Ablin expects moderate U.S. growth, he said a strong U.S. dollar has the potential to dampen the expansion."

Interestingly, the Economic Surprise Indices readings could be suggestive of a market environment that is broadly favorable for a number of global equity markets. The desire by the U.S. Fed to get rates off the near zero level and data that pushes this further into the future and conversely, a number of central banks outside the U.S. pursuing quantitative easing measures, both can be positive for global equity markets.

Sunday, April 12, 2015

Expecting A Weak Q1 2015 Earnings Season, But Looking At Forward Guidance

With first quarter 2015 earnings season beginning to hit full stride in the coming two weeks, earnings growth expectations for Q1 2015 are now negative at -4.6%. The last negative quarterly growth result was Q3 2012 as can be seen in the below table from Factset.

From The Blog of HORAN Capital Advisors
Source: Factset

Out of the small percentage of S&P 500 companies that have reported to date, 70% have cited the strong Dollar as the cause of their negative Q1 2015 report. As noted at the beginning of the article, the last negative earnings growth quarter occurred in Q3 2012. Importantly, these earnings reports are reflective of past results and investors will want to pay attention to forward guidance. Subsequent to the Q3 2012 negative growth quarter, the S&P 500 Index went on to generate outsized gains of 30% in 2013 as can be seen in the below table.

From The Blog of HORAN Capital Advisors

To provide some insight on the US Dollar strength and noted in the Factset report,
  • "During the course of the first quarter, the dollar strengthened relative to the euro. On December 31, one euro was equal to $1.21 dollars. On March 31, one euro was worth about $1.07 dollars."
  • "The dollar has also strengthened relative to year-ago values for both the euro and the yen. In the year ago quarter (Q1 2014), one euro was equal to $1.37 dollars on average. For Q1 2015, one euro was equal to $1.13 dollars on average. In the year-ago quarter (Q1 2014), one dollar was equal to $102.76 yen on average. For Q1 2015, one dollar has been equal to $119.17 yen on average."
Lastly, it should be noted the earnings and revenue expectations from the energy sector are a significant contributor to the Indexes overall decline in earnings and revenue growth. We believe, though, the lower energy prices are a net plus to the economy via the benefit the consumer receives from lower energy prices.

The first quarter reports almost seem like a replay from the first quarter of 2014 when weather across the country was a significant drag on economic growth. In Q1 2015 we had weather effects as well. On top of the weather, the West Coast Port shutdown also negatively impacted the retail segment. For investors, hearing forward guidance comments from the conference calls this quarter will be important in ascertaining future earnings expectations.

Friday, April 10, 2015

Emerging Markets Not Out Of The Woods Yet

As investors seem to be expecting an increase in interest rates by the Fed to be pushed out later this year, the emerging market trade has seen a positive impact relative to its U.S. developed counterpart. As the below chart shows, on a year to date basis the iShares MSCI Emerging Markets ETF (EEM) has moved up 9% versus the S&P 500 Index return of 2%.

From The Blog of HORAN Capital Advisors

This risk on appetite has carried over into small cap stocks as well. Year to date the Russell 2000 Index is up 5% versus the previously noted 2% for the S&P 500 Index.

From The Blog of HORAN Capital Advisors

These are a couple of divergences we mentioned in a post at the beginning of 2015 that the market would need to address, A Market Needing To Resolve Divergences In 2015.

Lastly, on a longer term basis, Dollar strength has historically been a headwind for emerging market investors. Maybe the rate increase cycle begins later this year; however, when it does, downward pressure could face emerging market investments as the rate increase nears.

From The Blog of HORAN Capital Advisors

Thursday, April 09, 2015

A Good Quarter To Be a Non-Dividend Paying Stock

Through the first quarter of 2015, performance would suggust it was a good time to be a non dividend payer stock. As the below table shows, the average return of the non-payers generated a return of 6.49% versus the payers average return of 1.16%. I would note, however, the average return in the quarter for both the payers and non-payers exceeded the cap weighted return of the overall S&P 500 Index.

From The Blog of HORAN Capital Advisors

Thursday, March 26, 2015

Strong Buyback Activity Reducing Share Count

S&P Dow Jones Indices is reporting that stock buybacks fell sequentially in the fourth quarter last year to $132.6 billion from the third quarter level of  $145.2 billion. However, on a year over year basis, buybacks increased by 2.5%. this still strong buyback activity has served as a tailwind for earnings growth as the report notes 20% of the S&P 500 companies have reduced their share count. Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices notes, "...While fourth quarter expenditures were down 8.7%, the number of issues reducing their share count by at least 4% year-over-year, and therefore increasing their EPS by at least that amount, continues to be in the 20% area – a significant level." Other key metrics noted in the report:
  • "More issues reduced their share count this quarter than last, with 308 doing so in Q4, up from 257 in Q3 and 276 in Q4 2013."
  • "Significant changes (generally considered 1% or greater for the quarter) continued to strongly favor reductions, and also increased, as 117 issues reduced their share count by at least 1%, compared to last quarter’s 101 and the 112 which did so in Q4 2013."
  • "Share reduction change impacts of at least 4% (Q4 2014 over Q4 2013), which can be seen in EPS comparisons, were flat at 99 in Q4 2014 from Q3, but up from the 83 posted in Q4 2013."
Although the earnings growth trend appears to be slowing, cash generation continues to be strong for companies. Silverblatt notes with banks now appearing to focus on dividends and buybacks, 2015 could witness another strong year for dividends and buybacks for the S&P 500 Index.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Data Source: S&P Dow Jones Indices

Thursday, March 19, 2015

Bullish Sentiment Declines To Level Last Seen In Early 2013

This morning the American Association of Individual Investors reported individual investor bullish sentiment declined to 27.2% versus last week's reading of 31.6%. This is the lowest level for bullish investor sentiment since April 4, 2013. Additionally, today's report places the sentiment reading at one standard deviation below the average sentiment level. The decline in sentiment over the past week is proving its status as a contrarian indicator as the S&P 500 Index is higher by 2.9%.

From The Blog of HORAN Capital Advisors
Source: AAII

Saturday, March 14, 2015

Bearish Equity Sentiment Showing Up In The Equity Put/Call Ratio

As we noted Thursday, the American Association of Individual Investors reported a further decline in its bullish sentiment reading. The reported level of 31.6% is near a level indicative of overly bearish investor sentiment. Further confirmation of this bearish sentiment is seen in Friday's equity put/call ratio which is reported at .80. As with the AAII bullish sentiment reading,  the equity put/call ratio is most predictive at extreme levels or above 1.0. Nonetheless, overly bearish investor sentiment is suggestive of a near term equity market bounce.

From The Blog of HORAN Capital Advisors

Thursday, March 12, 2015

Investors Less Bullish As Market Nears Oversold Level

The American Association of Individual Investors reported an 8.2 percentage point decline in bullish investor sentiment to 31.6% this morning. This is the lowest bullishness level since bullish sentiment was reported at 30.89% in early August of 2014.

From The Blog of HORAN Capital Advisors
Source: AAII

This decline in bullish sentiment has occurred at a time when the S&P 500 Index appears to be nearing an oversold level. As the below chart shows, the technical stochastic indicator has fallen to an oversold level. The money flow indicator and MACD indicator have yet to confirm an oversold level; however, the market does appear to be nearing a potential bounce level. In the recent past the 150 day moving average has served as a support level for the S&P 500 Index and it will be important that this level (2017) is held in this recent pullback.

From The Blog of HORAN Capital Advisors

Sunday, March 08, 2015

Additional P/E Multiple Expansion Possible Until The First Fed Rate Hike

A common occurrence in equity bull market cycles is the fact that a company's valuation, or P/E multiple, expands. This so called multiple expansion is one factor that contributes to overall equity returns during bull market phases. The downside to multiple expansion is it does not occur ad infinitum. As the below chart shows, the P/E multiple for the S&P 500 Index has expanded by 64% by increasing to 17.3x earnings versus 10.6x earnings at the start of the current bull market.

From The Blog of HORAN Capital Advisors

One factor that will cause multiple expansion to come to an end, and ultimately revert to contraction, is an increase in interest rates. The reason for this is investors will value future earnings less when a higher discount rate is used to value those earnings in equity valuation models.

The market took Friday's job report as another sign the Fed is nearing a time where it will increase short term interest rates. The job report showed 295,000 jobs were generated in February. The report also noted the unemployment rate declined to 5.5%, which is the lowest level since May 2008. One data point that continues to generate differing points of view is the labor force participation rate. This part of the report noted the participation rate fell slightly to 62.8% from 62.9%. Many market strategists are viewing the jobs report as another sign the Fed is nearing an end to easy monetary policy and a rate hike in June or at the latest by the end of summer.

So with a rate hike nearing, will market forces result in a P/E multiple that begins to contract? Historical data shows; however, market multiples have broadly expanded up until the time of the first rate increase. A report by Sam Stovall, U.S. Equity Strategist for S&P Capital IQ, notes, "After examining the 16 times since 1946 that the Federal Reserve started a rate tightening program, the median multiple on trailing 12-month GAAP (or “As Reported”) EPS rose from 17.7X six months before to 17.9X three months before and 18.5X on the date of the first rate increase. Only in the three and six months after the Fed started raising rates did the P/E median decline to 18.1X and 16.7X, respectively." In a recent report from Goldman Sachs, they include a table comparing S&P 500 returns along with the impact on valuations before and after Fed rate increases. As can be seen in the below table, P/E multiples and returns are positive up to the first rate increase.

From The Blog of HORAN Capital Advisors

Also, given the near zero level of interest rates along with the low level of inflation, equity valuations are not as stretch as they may appear in nominal terms.

From The Blog of HORAN Capital Advisors

The Fed does appear to be in a position where an interest rate increase is likely to occur this year. One could surmise the Fed is in a position where they need to get rates back to a more normalized level. At this near zero interest rate level, the Fed has fewer monetary options to implement in the event an economic shock where to occur. Additionally, because rates are at artificially low levels, history has shown there is a positive correlation between stock prices and interest rates when rates rise from levels below 5%.

From The Blog of HORAN Capital Advisors

A part of the reason for this is when rates are at such extreme lows, initial rate increases are instituted simply to get rates back to a more normal level. When rate increases occur at levels higher than 5%, this can be a sign of an overheating economy with the Fed's intention to slow down the economy. As the economy slows, corporate earnings are likely to slow, resulting in equity prices declining as well.

For investors then, as a rate hike does seem near,  positive equity market returns can be achieved up until the time the first rate increase occurs. Also, a portion of the returns can be generated from a continued expansion of P/E multiples.

Friday, February 27, 2015

Market Advance Not Extraordinary In Terms Of Magnitude And Duration

In prior post over the past year I have highlighted the current market advance as it relates to prior bull markets. This information has been prepared by Chart of the Day and the below chart and commentary updates the comparison for the Dow Jones Industrial Average. The most recent commentary for the S&P 500 Index is included in the post, Current Stock Rally Below Average In Magnitude.
"The Dow just made another all-time record high. To provide some further perspective to the current Dow rally, all major market rallies of the last 115 years are plotted on today's chart. Each dot represents a major stock market rally as measured by the Dow with the majority of rallies referred to by a label which states the year in which the rally began. For today's chart, a rally is being defined as an advance that follows a 30% decline (i.e. a major bear market). As today's chart illustrates, the Dow has begun a major rally 13 times over the past 115 years which equates to an average of one rally every 8.8 years. It is also interesting to note that the duration and magnitude of each rally correlated fairly well with the linear regression line (gray upward sloping line). As it stands right now, the current Dow rally that began in March 2009 (blue dot labeled you are here) would be classified as below average in both duration and magnitude."
From The Blog of HORAN Capital Advisors