Monday, February 20, 2017

The Significance Of The S&P 500 Yield Falling Below The 10-Year Treasury Yield

For most of 2016 the dividend yield on the S&P 500 Index was greater than the yield on the 10-year U.S. Treasury. Historically, this has served as a positive sign for forward stock price returns. With the strong equity market returns in 2016 and the move higher since the election, the S&P 500 yield is now lower than the 10-year Treasury. In addition to the move higher in stocks, bond prices have declined as well (a higher yield) resulting in bonds now having a higher yield than the S&P 500 Index.

Sunday, February 12, 2017

Recent Outperformance Of Low Volatility A Sign Of Risk Off Ahead?

Since the election in the U.S. it has been a 'risk on' environment for stock investors. Last week though, the Powershares Low Volatility ETF (SPLV) broke out of a sideways trading range to the upside. At the same time, the Powershares High Beta ETF (SPHB) remains trapped in a sideways range. Might the move higher in the low volatility ETF be a signal there is underlying action by some investors to be more defensive in anticipation of a potential pullback on the horizon? The third chart below compares the high beta ETF performance versus the low volatility ETF performance since the election and high beta has far outperformed low volatility.

To better understand what is and is not working in both of these ETFs, following is a summary of the sector attribution for both investments.

The first table above shows some of the attribution for the low volatility ETF (SHLV) compared to the S&P 500 Index. Notable for SHLV:
  • The consumer staples weighting is nine percentage points higher than in the S&P 500 Index. This added 21 basis points to the overall outperformance. 
  • the utility sector is 19 percentage overweight versus the S&P 500 Index and this added 17 basis points to the outperformance
  • SHLV contains no energy stocks and this added a small 3 basis points
In regards to the high beta ETF (SPHB), notable differences versu the S&P 500 Index are:
  • the financial sector is 15 percentage poitns overweight compared to the S&P 500 Index and this added 30 basis points to its outperformance
  • SPHB is 20 basis overweight to the S&P index and this resulted in a negative 44 basis point versu the S&P and noting SHLV contains no energy positions.
  • SPHB is comprised of no consumer staples positions and this cost the index 10 basis points versus the S&P 500 Index and a full 1.68% versus the low volatility index, SHLV.
The equity markets, and specifically the S&P 500 Index, seem to know only one direction and that has been up. Since the election the U.S. the S&P 500 Index is up 8.8% through the close on Friday and the index is up 27.8% on a one year basis. As Charles Kirk of The Kirk Report has been saying about this market,
"At this point, the continued strength is starting to overcome the historical pattern for a post-inaugural pullback in the first month...The Bottom Line: It remains a bull market until proven otherwise [emphasis added]...and prices are still not showing any new signs of vulnerability as the test of upper trendline resistance begins."
I have written recently that individual investor sentiment reported by AAII is trending more cautious and the below chart also points to a similar conclusion.
One week certainly does not constitute a trend. However, the strength of the S&P 500 Index advance over the last eight years and the recent extreme low volatility of the broader market warrants one to expect a pullback in stocks. The S&P 500 Index has not seen a move of greater than +/-1% since December 7, 2016.

It is apparent the defensive sector weighting of SHLV has benefited its return against both the high beta ETF and the S&P 500 Index, i.e., over weight in staples and utilities.  Longer term though, the balance of the year, we continue to believe stocks will reward investors.

Saturday, February 11, 2017

Positive Sentiment And Fundamentals Rests On Positive Political Expectaions

I believe there are two broad issues at play that are having a positive influence on equity prices. The first issue is a fundamental one and related to a much improved corporate earnings picture. Looking solely at companies in the S&P 500 Index, Thomson Reuters publishes a weekly report summarizing the quarterly earnings reports of companies. Friday's report notes,
  • Q4 '16 earnings are expected to increase 8.4% on a year over year basis. The financial sector is projected to show the strongest YOY growth at 20.8%
  • Of the 357 companies in the S&P 500 that have reported earnings to date for Q4 2016, 68.3% have reported earnings above analyst expectations. This is above the long-term average of 64% and below the average over the past four quarters of 71%.
  • 48.3% of companies have reported Q4 2016 revenue above analyst expectations. This is below the long-term average of 59% and below the average over the past four quarters of 51%. Revenue growth for Q4 '16 is estimated to equal 4.4% YOY.
The second issue influencing the market is the dramatic positive shift in sentiment by both consumers and businesses. I could probably show a dozen different charts that support the positive shift in sentiment with just two of them below. The first one measures CEO Confidence and it had one of  the largest month over month increases in the measure's history. The second one shows consumer sentiment jumping higher subsequent to the election as well.

Monday, February 06, 2017

Room For More Debt?

As was mentioned in a previous post, S&P 500 companies have taken advantage of cheap debt to fund continued capex and share buybacks since the recession.  This has driven total debt to new all-time highs.  Though there has been much concern about the "abuse" of low interest rates to create a rally fueled by buybacks, it does not strike me as much of an issue.  In fact, it makes sense for companies to take advantage of cheap debt to lower their WACC with the potential side effect that they shift their capital structure.  Interestingly, however, the capital structure has not shifted with this proliferation of cheap debt.

The total debt to book value of equity ratio appears to be at a reasonable level.  If anything, it looks like there may be room for additional debt for S&P 500 companies.  This is even more true when coupled with the very low interest expense burden.  It is not that debt has not grown since the last recession, it clearly has, but the book value of equity has grown much faster.

I am not necessarily campaigning for these companies to take on more debt, but rather observing that corporate debt (at least in the S&P 500) does not seem to be nearly as big a problem as is often reported.

Sunday, February 05, 2017

Dogs Of The Dow 2017: Know The Strategy's Bets

The Dogs of the Dow strategy is one where investors select 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 year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year. The popularity of the strategy is its singular focus on dividend yield.

As we noted in a year end post, the Dogs of the Dow strategy in 2016 did outperform both the S&P 500 Index and the Dow Jones Industrial Average Index last year. However, the strategy is somewhat mixed from year to year in terms of outperforming the Dow index though. Over the last ten years, the Dogs of the Dow strategy has outperformed the Dow index in six of those ten years. For investors utilizing the strategy it is important to be aware of where ones bets are in terms of stock and sector exposure.

Essentially one months has passed in 2017 and the Dogs of the Dow strategy is underperforming both the Dow index and the S&P 500 Index. Below is a table noting the year to date performance of the current Dogs.

In evaluating the performance difference, investors will note the largest detractor from performance is related to the energy sector. The 2017 Dow Dogs contain two energy stocks, Exxon Mobil (XOM) and Chevron (CVX). In 2016 the energy sector was the best performing sector in the S&P 500 Index, up 28%. To date in 2017, for the S&P 500 Index, energy is the second worst performing sector, down 2.5%, followed by telecom stocks which are down 3.3%.

The below table details the attribution analysis of the Dow Dogs to the Dow Jones Industrial Average Index itself.  As one can see, the Dogs of the Dow strategy is overweight to the energy and telecom sectors, thus, detracting from the strategy's year to date performance. Also of note is the absence of holdings in the Financial, Materials and Consumer Discretionary sectors. In comparison to the S&P 500 Index, the Dogs, and the Dow index itself for that matter, do not contain positions in utilities or REITs.

For investors then, if the Dogs of the Dow strategy is one being pursued, it is beneficial to know where the strategy's bets are in terms of stocks and sectors. As noted previously, the Dow Dogs contain no materials stock positions and this sector is the second best performing sector in the Dow Index and the S&P 500 Index. Also, if one believes financial stocks can continue to perform well this year, the Dow Dog strategy is absent any financial positions. At the end of the day, investors will benefit knowing what they own and the economic exposure of these holdings.

Sunday, January 29, 2017

YTD Equity Market Declines In 83% Of All Up Years Since 1945

CFRA Research, in conjunction with S&P Global, recently published a report on the probabilities of a market pullback. A number of interesting data points are outlined in the report, but a few interesting ones are as follows:
  • "during bull markets since 1945, the S&P 500 experienced a pullback (a decline of 5.0%-9.9%) once a year, on average,"
  • "a correction (a 10% to 19.9% decline) every 2.8 years, and,"
  • "a bear market (-20%+) every 4.7 years."
  • "the S&P 500 suffered a YTD price decline in more than 80% of all years in which the S&P 500 recorded a positive annual performance since WWII."
As further proof that the market does not move higher in a straight line, the CFRA report notes the S&P 500 Index incurred a year-to-date price decline in 83% of all up years since 1945.

Also interesting in the report is the fact that 70% of all year-to-date declines occurred in the first quarter of the year and approximately a third of all the year-to-date declines occurring in January.

The entire report is a worthwhile read as it contains data on the market's performance after surpassing millennial points.


Pullback Probabilities
CFRA research
By: Sam Stovall, Chief Investment Strategist
January 17, 2017

Saturday, January 28, 2017

Market Breaks Out Of Sideways Trading Range To The Upside

Over the course of the last three trading days this week, the S&P 500 Index and Nasdaq broke out of the trading range in place since mid December. We highlighted this range in a recent post that noted sizable corrections are unlikely when earnings are improving.

Friday, January 27, 2017

Buybacks vs. Capex

The below chart shows that through the end of 2015, S&P 500 companies were contributing a similar percentage of revenue to capex as they were back in 1995 (6.495% in 2015 vs. 6.5% in 1995). This same percentage capex contribution, however, is now only covering 113.4% of depreciation, when it covered 132.73% at the end of 1995.

[Note: going back to 1980 or 1990 shows that companies are clearly investing significantly less in capex since then, but for the purposes of this post it was sufficient to show that it is relatively unchanged in the past twenty years.] 

Amidst all of the worries about excessive share repurchases, companies have managed to reinvest the same portion of revenue. The difference is not that companies are investing less, but that a larger percentage of this capex is required as effectively maintenance capex. This is due, in part, to the divergence in the growth rates of Depreciation and Revenue that began at the end of 2012 (as seen below). This was initially offset by an increased reinvestment rate in 2014.

This is not to say that buybacks and dividends have not increased in recent years, but the increase does not appear to have come at the expense of reinvestment. Rather, much of it seems to have come from new debt issuance, but we do not necessarily view this as a bad thing. The below chart demonstrates that while Total Debt for S&P 500 companies has easily surpassed the previous 2008 peak, Net Debt is still well below the peak and Interest Expense is even lower.

Companies have taken advantage of cheap debt and large cash balances (much of which may be repatriated under new administration), they have not sacrificed reinvestment.

Thursday, January 26, 2017

Individual Investors Cautious On Equity Market

If the contrarian individual investor sentiment measure reported by the American Association of Individual Investors indicates anything, individual investors seem to be questioning the sustainability of this market rally. Because the Sentiment Survey is a contrarian measure, just maybe the market advance has further upside. In AAII's report this morning, bullish sentiment fell 5.4 percentage points to 31.6% which is nearing an extreme for the reading. Most of the decline in bullish responses showed up in the neutral reading as it increased 4.6 percentage points to 34.9%. This is the highest neutral rating since it was reported at 42% in early November of last year.

Wednesday, January 25, 2017

Second Longest S&P 500 Rally Since 1932

Chart of the Day's report this morning notes the S&P 500 Index return since the October 2011 low is now the second longest since the Great Depression. Specifically, their commentary notes,
"With the S&P 500 once again in record high territory, today's chart provides some perspective on the current rally by plotting all major S&P 500 rallies of the last 86 years. With the S&P 500 up 107% since its October 2011 lows (the 2011 correction resulted in a significant 19.4% decline), the current rally is above average in magnitude and the second longest rally since the Great Depression."

- A major stock market rally has been defined as a S&P 500 gain of 30% or more (following a correction of at least 15%).
- The S&P 500 was not adjusted for inflation or dividends.
- Selected rallies were labeled with the year in which they began.
- There are 252 trading days in a year (100 trading days equal about 4.8 calendar months).