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Mark's Investment Strategies Blog

This blog is intended to keep clients and friends current on my investment management activities. In no way is this intended to be investment advice that anyone reading this blog should act upon in their personal investment accounts. There are other significant factors involved in my investment management activities that may not be written about in this blog that are equally as important as the things that are written about that materially impact investment results. Neither is this blog to be construed in any way to be an offer to buy or sell securities. To be notified via e-mail when new posts are made, click on the subscribe button below. To view previous investment strategies, click strategy downloads.
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What Is The Market Saying?

May 28th, 2015

sp-500-pmo

Click on any chart for a full size version

I thought we ought to take the temperature of the market and see what it is trying to tell us about the status of the current bull run. To do that, I have included four long-term trend charts that I have watched over the years that help me know when to get conservative with client money and when to get aggressive. Let’s see what they say.

Above is a 20-year chart of the monthly S&P 500 with the Price Momentum Oscillator (PMO) at the bottom. You can see that I have circled various points in time where the blue PMO line has crossed over its red indicator line. A cross to the downside indicates the market is weakening and a cross to the upside indicates the market is strengthening

The change in the PMO generally coincides with a change in trend for the stock market (see the circles in the index where it crosses below its long-term moving average). As prices begin to weaken and investors’ buying enthusiasm wanes, the PMO captures that before prices fall enough to do too much damage to a portfolio. The really important thing to note here is on the magnification of the chart at the far right. You can see that the PMO has had a negative cross-over -- IF history provides any indication as to patterns within the stock market, the stock market should weaken and turn down soon.

Notice I said IF because chart watching is an art and not a science.

trix-divergence

This chart is another one that concerns me. It is a daily chart of the S&P 500 compared to the TRIX Indicator. The TRIX is a momentum-only indicator and tells us when the market is starting to weaken. You can see I’ve drawn boxes around times when the TRIX is pointing to a change in market direction and I’ve drawn circles around the market’s divergence with the indicator UNTIL it changes direction. The important thing to see here is on the far right side of the chart -- there is a negative divergence where the TRIX has turned negative but the market continues to move higher. IF history provides any indication as to patterns within the stock market, the stock market should weaken and turn down soon.

Notice I said IF because chart watching is an art and not a science.

sp-monthly

The final chart above shows the monthly S&P 500 index compared to its 10 month moving average and includes a Relative Strength Index (RSI) -- a momentum-only measure of the speed and rate of change of a price move. In this one, I’ve drawn circles around times where the RSI is showing readings that are either overbought (where there are too many bulls -- a contra-indicator) and oversold (too many bears -- also a contra-indicator). I have also drawn circles around times when the S&P has crossed over its 10-month moving average line. You can see that when they both happen, it represents a fairly long-term change in trend. At the moment, we have the RSI showing an over-bought reading but the S&P still above the 10-month moving average. IF history provides any indication as to patterns within the stock market, and the S&P index crosses its 10-month moving average to the downside, the stock market should weaken and turn down, possibly into more than just a correction.

Notice I said IF because chart watching is an art and not a science.

These are three fairly important charts for me and at the moment they are flashing caution. We have built up a 4% to 5% (of equity exposure) cash cushion in client accounts as these charts started to turn negative. We will hold onto that until we see definitive sighs of a trend change to the downside -- if it happens.

I want to be clear -- there is no guarantee that the market will go down. It could continue higher or even move sideways for a time. In fact, here is where the art of chart reading comes in -- this chart shows that the top three may be flashing false signals:

sp-with-regression-channels

This chart shows the S&P 500 Index with a regression channel that I’ve drawn. You can see that the market has moved within this channel for the past 6+ years. The channel is marked by upper and lower boundary lines with a mid-point line. The current move by the market is very consistent within the upper half of the channel. This type of move indicates a strong uptrend, and until we see it move into the lower half of the channel the trend is definitely in tact.

So for now I am going to exercise my art degree and carry on with the plan to be cautious but remain 95% invested until all four of my indicators tell me that a correction is near.

Mark

I’ll Take the Double

May 4th, 2015

ctsh

On May 28, 2013, we purchased our position in Cognizant Technology Solutions at $64.20 (which split 2 for 1 on March 10, 2014) and today hit $64.71, up 10% on the day. We were able to double our investment for a bit over a 100% gain in under two years.

As you look at the chart above, there is one thing that really stands out to me -- during 2014, this company traded in a side ways to down pattern, with a loss on the year of about 20%. We opted to hold onto our shares during this time because our analysis of the company showed that it was operating at the top of its game.

Below I’ve excerpted some of the items from our internal analysis of the company:

1. Operating Performance

ctsh-operating-performance

Earnings Per Share growing at > 21%
Sales growing at > 25%
Book Value growing at > 21%

These are great metrics and indicate that the company is operating on all cylinders.

2. Operating and Valuation Ratios

ctsh-key-statistics

As you can see from our Key Statistics grid, this is a company that is an investors dream. A couple of highlights from this grid are: 1) Its return on invested capital -- a measure of how efficiently management is using investor capital to generate returns -- is three times is cost of capital, a truly amazing achievement; and 2) Its PEG ratio is 1.29, indicating this company is currently trading at just 29% above its growth rate, making it somewhat of a bargain particularly in light of #1 above.

3. Valuation

ctsh-over-under-valued

The grid above is one measure of how I calculate whether a company is over-valued or under-valued at current prices. I like to compare the current price of the company’s stock to its historic price multiple -- but for this calculation I blend together the price-to-book, price-to-cash flow, and price-to-earnings multiples for the past 10 years. You can see that based upon this calculation, the company is undervalued even after its run higher over the past two years.

4. Proprietary Ranks

ctsh-ranks

I’ve written on the blog several times in the past about our proprietary ranking system that ranks a universe of 6,000+ stocks on a bell curve based upon two sets of ratios. One set of 18 ratios provides an Earnings Growth rank and the other set of 10 ratios provides a Financial Strength rank, with zero being the worst and 100 being the best. Since it is a bell curve rank, the bulk of the ratings fall in the middle with few companies at each end. Cognizant ranks quite high on both measures, providing that enviable position of having strong and sustainable earnings growth while not taking too much risk from a balance sheet perspective.

5. Free Cash Flow

ctsh-free-cash-flow

Free cash flow is the amount of cash available for dividends, share buybacks, book value growth and future shareholder rewards AFTER investment in property, plant and equipment. It is an important metric in a large cap company and I prefer to look at it in comparison to its history. As you review the bar graph above, you can see that CTSH has had a steadily growing FCF over the past decade and is supportive of the return on invested capital calculation above in identifying how efficiently management is operating the company to the benefit of the shareholders.

After a review of the financials I am comfortable continuing to hold onto this investment even though we have doubled our initial investment in it. In today’s investment world, investors have too short of a time-frame for their investments. The price performance during 2014 likely caused many investors to sell out of this holding without analyzing its operating performance.

The pressure on investment managers to beat the index on arbitrary time-frames like monthly, quarterly and yearly cause many to dump potentially lucrative holdings in favor of a momentum stock that is doing great today but might not have the operating performance to sustain a price move like Cognizant’s.

The lesson to be learned from this investment is that stock price will ultimately reward superior operating performance. It is not always easy to stick with a company whose stock price is not following the market, even when the company’s operating performance shows that the market is mispricing it. The mispricing is actually an opportunity to buy (or hold onto it if you bought earlier) that will ultimately reward you in a meaningful way -- maybe the mispricing will not resolve itself as quickly as CTSH did but ultimately it will. Investors and investment managers just need to look longer term and not surrender to the pressures of trying to beat the index in the short-term.

Mark

Black Gold, Texas Tea

April 15th, 2015

wtic

We had a huge move in the price of oil today, up 5.5%. Oil is now at its highest price in 2015 and back to December levels. I’ve drawn a horizontal blue line on the price graph above so you can see what the move looks like.

From a technical standpoint, oil has moved fast and furiously into an over-bought status. You can see the blue circles I drew on the short-term indicators we follow -- below the price graph those indicators are in over-bought status and above the price graph the Relative Strength Indicator is about to move above its upper threshold.

From a fundamental standpoint, has much changed? The world is still producing more oil than it uses -- however many fields have been shut down and several off-shore rigs have been taken out of production. That is having an impact at the margin, as is the sale of larger cars, trucks and SUV’s far outpacing smaller fuel efficient cars, hybrids, and electric vehicles.

At $56 per barrel, oil is still low by comparison to the past few years -- yes you might see the price at the pump head up a bit, but it will take a lot more reduced drilling and a lot more gas guzzling vehicles on the road before we get to the point where demand is outpacing supply. How long will that be? Definitely not 2015 -- likely not 2016 -- probably not even 2017 -- but never underestimate the power of humans to jump headfirst into something, like shuttering too many wells or ignoring the recent past’s gas prices and buying gas guzzlers they can’t afford at minimally higher gas prices.

From a technical standpoint, the overbought status will correct itself, either by a pull back in the price of crude oil or by it trading sideways for a period of time. Given how low it still is at current levels, and that the intermediate trend indicator on the graph above ( the MACD which is not annotated ) is showing an upward trend has been established, I would not anticipate a significant pullback in price.

Oil and oil stocks have been significantly shorted by hedge funds and other institutional investors, so a lot of this price movement up has been their buying to cover their short positions so that they stop the losses that began when oil started to move up a month ago. The trading since Friday looks suspiciously like short covering driving the price higher rather than any fundamental change in the value of oil. That sort of human reaction to stop the pain of losses can overpower both fundamental and technical aspects of investing much like a stock market crash is driven by panic selling -- in this case its the opposite of that, panic buying.

Anything can happen to a commodity that is impacted by supply, demand, heavily shorted positions, and geopolitical forces -- the best thing to do is invest according to your preferred methodology (if you are a trend follower, continue to follow your trend; if you are value investor or growth investor, follow your valuation or growth metrics) and try to avoid getting caught up in either panic buying if you believe that the bottom was put in on March 16th and you are under weight energy or panic selling if you see that your oil stock has gained 20% since March 16th and you believe that it can’t run any further.

As I’ve written on this blog many times, invest what you see, not what you believe. I see the shorts panic buying and pushing some of the bottom fishing positions I purchased in mid-March higher (for example, our Baker Hughes is up 24%, our Concho Resources is up 32%, our Occidental Petroleum is up 13%) higher, yet they are still undervalued on a historic multiple basis so I see no reason to sell even though I believe they could pull back some in the near-term. You have to make similar decisions in your portfolios, just make sure you keep the emotion out of it.

Mark

S&P 500 In Foreign Territory?

April 1st, 2015

sp-2015-04-01
Double Click the image for a larger view

The graph above is a bit busy, but I wanted to show it to you as the indicators we follow are fairly consistently saying that we are due for a bit of a pullback in the index. I thought we could go through each of the indicators so you can have a feeling for what I see and the annotations I’ve made.

So, lets start with the panel at the top. This is a line graph of the S&P 500 with the 50 and 200 day moving average lines overlaid upon it. Additionally, I’ve drawn two green trend lines that form a descending triangle shape and an arrow. The descending triangle shape is fairly concerning because statistically the market breaks out of the triangle to the downside about 2/3 of the time. Also concerning about the graph in this panel is the fact that you can see the index has fallen below the 50 day moving average line -- this is a reversal from a intermediate term bullish trend to intermediate term bearish trend.

The next two panels are just informational -- they show the price performance of the S&P 500 over the past six months. The pink one is relative to the S&P 100 index, which you can see the S&P 500 is outperforming by 2.5% and the purple one is simply the S&P 500 performance, which is up a bit under 6% for the same period.

The panel below that is the Vortex indicator which tells you whether the market is behaving in a short-term bullish or bearish manner. When the green line is above the red line, you have bullish action and when the red line is above the green line you have bearish action. You can see in the red circle I’ve drawn that we’ve had a few days of bullish action, but that it looks like we are headed for a cross over into bearish territory.

The next panel is the Bolinger Bandwidth indicator. Bolinger Bands are not shown on this graphic, but one of their primary uses is to be an indicator of when the market might make a big move. Generally, the lower the reading on the indicator, the more anticipated volatility you will experience in coming trading days. At the current low level, we are due for a breakout in one direction or another. Given the other indicators we will discuss here, the likelihood is a breakout to the downside in the not-too-distant future.

The next panel is our primary price candlestick price graph. I’ve drawn two rectangles on this graph: the red one shows you how the 150 day moving average provided support to the market during the December/January time frame as the market basically traded sideways; the green one shows you how the 100 day moving average is acting as support currently. If we break to the downside and do not recover within three days or three percentage points (Mark’s Rule of Three for long-timer readers of the blog) then the most likely next move is to the same level the market traded in the December/January time frame, or roughly 2000 on the index.

The panel below that is the Relative Strength Indicator. What is important to note here is that the reading is below 50 and falling. This indicates that the market is losing strength and that prices could fall with it.

The panel below that has an orange box around part of the Money Flow area graph. This orange box shows that money flow has turned negative (meaning there is more selling pressure than buying demand for stocks).

Of the bottom five panels, I’ve added four pink arrows to show you that these indicators (which are all variation on price/volume indicators) are all in negative territory and even with the bullish action of the past few days shown by the vortex indicator discussed above, they could not break into positive territory.

After six years of the current bull market, investors appear to be tired and are experiencing that foreign concept of NOT seeing buyers materialize to “buy the dip.” With the prospect of the Federal Reserve raising interest rates this year, investors seem adopting a wait and see attitude, taking some money out of the market and booking some profits. We are part of that crowd, having added roughly 5% or so in cash equivalents to client portfolios as well as rebalanced holdings to book profits in holdings that have outperformed the broader market. In the rebalancing process, in anticipation of the Fed raising rates, we have increased our allocation to banks that should benefit from higher interest rates. We’ve also added to our holdings of companies that should be interest rate neutral given the low or no debt on their balance sheets.

Technical analysis is misunderstood by many investors as well as many people in the industry. Many believe it to be more science than it truly is -- to me, it is just a representation of the investing public’s emotional attachment to the stock market. When the indicators are positive, you have investors adding money to the market because they believe it will continue to move higher and make them money. When the indicators are negative, it is just the opposite. Right now I think we are at or near the beginning of the time where that six year move higher may be running out of steam -- it is unclear when or how large of a move down is possible, the indicators are not giving us any sort of reading on that -- but the likelihood is that we are headed down more than we are headed for new highs.

The following video I made myself -- so if you hate it, don’t tell me because I had fun at the concert and making the video of it.

Mark

Happy Anniversary Bull Market

March 9th, 2015

image2

Today is the 6th anniversary of the post-crash stock market bottom, so just a quick note this morning as I’m at the Retail Banking Conference. I wanted to share a chart that is pretty interesting -- it’s Marty Chenard’s graph of the S&P 500 since 2009’s crash bottom showing a well defined rising wedge pattern.

Here is the definition of a rising wedge from Stockcharts: The Rising Wedge is a bearish pattern that begins wide at the bottom and contracts as prices move higher and the tracding range narrows. In contrast to symmetrical triangles, which have no definitive slope and no bullish or bearish bias, rising wedges definitely slope up and have a bearish bias.

This type of technical analysis is important because it gives you insight into investor psychology more than anything else. It basically tells you that investors get complacent as prices increase and are less inclined to sell on bad news. Generally they take on more risk and possibly utilize margin loans to buy stock that they otherwise can’t afford. Then at some point they see the gains they’ve made and some begin to take profits. Then bad news at some point matters and the selling begins as investors want to preserve as much of their profits as they can. That drives the prices down and the index falls below the bottom line in the rising wedge.

So as with some of the other articles I’ve published recently, this is just a sign that a bit of caution is warranted as this market has risen so much in the past six years.

Our goal is to have some cash in client portfolios to buy companies cheaper when the inevitable pull back happens -- not too much because we don’t want to underperform in the short term. We are also de-risking by rebalancing portfolios and taking some money out of big winners to get them back to strategic allocation percentages and adding to under performers also moving them back to strategic levels. Why is this de-risking? The winners have become overvalued and the underperformed shave become undervalued.

Enough for now as our meetings start soon, but I’ll be tuned into the market during the conference and will be taking any needed actions if anything eminent happens in the market.

Mark

Happy Anniversary Bull Market

March 9th, 2015

image1

Today is the 6th anniversary of the post-crash stock market bottom, so just a quick note this morning as I’m at the Retail Banking Conference. I wanted to share a chart that is pretty interesting -- it’s Marty Chenard’s graph of the S&P 500 since 2009’s crash bottom showing a well defined rising wedge pattern.

Here is the definition of a rising wedge from Stockcharts: The Rising Wedge is a bearish pattern that begins wide at the bottom and contracts as prices move higher and the tracding range narrows. In contrast to symmetrical triangles, which have no definitive slope and no bullish or bearish bias, rising wedges definitely slope up and have a bearish bias.

This type of technical analysis is important because it gives you insight into investor psychology more than anything else. It basically tells you that investors get complacent as prices increase and are less inclined to sell on bad news. Generally they take on more risk and possibly utilize margin loans to buy stock that they otherwise can’t afford. Then at some point they see the gains they’ve made and some begin to take profits. Then bad news at some point matters and the selling begins as investors want to preserve as much of their profits as they can. That drives the prices down and the index falls below the bottom line in the rising wedge.

So as with some of the other articles I’ve published recently, this is just a sign that a bit of caution is warranted as this market has risen so much in the past six years.

Our goal is to have some cash in client portfolios to buy companies cheaper when the inevitable pull back happens -- not too much because we don’t want to underperform in the short term. We are also de-risking by rebalancing portfolios and taking some money out of big winners to get them back to strategic allocation percentages and adding to under performers also moving them back to strategic levels. Why is this de-risking? The winners have become overvalued and the underperformed shave become undervalued.

Enough for now as our meetings start soon, but I’ll be tuned into the market during the conference and will be taking any needed actions if anything eminent happens in the market.

Mark

Pigs Get Fat, But Hogs Get Slaughtered

March 5th, 2015

kroger

I often give you graphs telling you what to do in certain situation based upon the indicators I follow.

Well, today I want to show you what NOT following the indicators can do -- particularly if you get greedy and want to play the market too cute.

Case in point: Kroger

If you haven’t been following Kroger, this formerly stodgy grocery store has transformed itself into an aggressive competitor of both Whole Foods and Walmart, providing both upscale options for the nutrition conscious consumer and a low price selection for the value conscious consumer. Their growth rate has become tremendous and they are now the country’s second largest retailer.

Its a company I’ve wanted to add to client portfolios for quite awhile, but I always wanted to buy it at the 50-day moving average. If you look at the graph above, I’ve annotated it with two green arrows showing the last two times this company hit the 50-day moving average in the past 12 months. If you look in the green box I’ve drawn, you can see that the price was moving down toward the 50-day moving average in recent days, but my indicators (circled in red) were flashing that the stock had fallen too much. I second-guessed them, because I was greedy and wanted to buy at that price thereby reaping the big rewards for client portfolios, and opted to wait for another day or two for the stock to go down a couple more percentage points and I’d buy it at the 50.

NOT HAPPENING…

This morning, Kroger announced incredible earnings (as I assumed they would) and the stock is up nearly 7% today to a new high. So, I am kicking myself because I wanted to buy it at a price my indicators clearly said was unlikely to be reached.

Indicators are not perfect, as I have found out over the years, but they are consistent enough to be relied upon as inputs to the decision process, particularly when trying to time buy/sell decisions. I just did not rely upon them.

There is an old saying in the investment business: “pigs get fat, but hogs get slaughtered.” As you can probably guess, it means making money is great, but don’t get greedy as you always lose out.

After 30+ years in the business, I continue to learn my lessons (and relearn them too sometimes).

Kroger goes back on my watch list and we move on to the next opportunity.


Can anyone guess what this video has to do with the blog post? Its obscure but if you’ve seen Pink Floyd in concert you will know exactly what the answer is.

Mark

NASDAQ Hits a Record After 15 Years

March 2nd, 2015

nasdaq-20-year

Today is big day in the markets -- its taken the NASDAQ 15 years to return to the 5,000 level that it reached at the pinnacle of the Dot Com mania of the late 90’s. Back then, investors were willing to throw money at just about anything that planned to use the internet as a delivery platform -- Pets.Com is the classic example of a multi-billion dollar company that was not much more than an idea, but investors threw so much money at it that it was valued higher than many established industrial companies that had actual products to sell and cash flow for operations.

Today, we complain that valuations are high (for example, Facebook at 71 P/E, Under Armour at 81 P/E, or Celgene at 50 P/E), but these are small potatoes by comparison to the mania pricing of 15 years ago. The big differential between then and now is that the companies with high valuations in general have real businesses that generate earnings. Investors can see where these earnings are going in the future and are willing to pay premium valuations today for the promise of high earnings in a few years.

All over the business news today, there is a debate about whether we are in another Tech bubble. That seems silly to me -- yes, P/E’s are high, but so are earnings growth rates. I think a more salient issue is whether we are at a cyclical peak and due for a bit of a pullback. Check out the graph below:

nasdaq-comp-annotated

I have circled several of the indicators that are flashing warning signs that the index has moved too high too fast. Does that mean it will definitely go down? For long time readers of the blog, you know that these over bought readings can be cured by either a fall in price OR by a movement sideways in price and the passing of time. Either is as likely as the other.

But the one thing I do want to point out to you is the red arrow I’ve drawn on the price graph. You can see that the index is having trouble breaking through the blue line which is acting as resistance. This blue line is the 10% band above the 200-day moving average. We haven’t discussed that band in a few months, but it is an important level for any stock or index. Indexes particularly have a difficult time trading at that level -- much of the time, it represents a near-term top in the price of the index and it represents a level where you want to be a seller more than a buyer -- in other words, it is a high risk area of the market.

Will it be the top this time? No one knows. If you are a gamblin’ man you might bet that the amount of money sloshing around the economy due to artificially low interest rates and money printed through the Federal Reserve’s Quantitative Easing program (as well as those of Japan and Europe) will keep the party going. However, in my opinion, it is better to be safe and cautious than wildly bullish at this level. Chances are good that we will see a bit of a pullback that will cure the over bought indicators and allow the index to pull back from the 10% band.

At least that is what I am looking for at this time.

Mark

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