Archive for August, 2015

August Recap

Monday, August 31st, 2015

SPX August

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August is finally past us and the S&P 500 lost -6.7%   –   although it could have been worse had we not bottomed and bounced the past couple of days.

In the past couple of blog posts, I told you I had been buying during the panic selling.  I won’t repeat the reasons for the purchases today, rather I point you to the previous few posts for clarity.

However, I thought you might like to see what we purchased with the cash we had on hand and how those have performed since we bought them.  So, below is the list of stocks we purchased and the percentage return since purchase:

Cal-Maine Foods  (CALM):  +7.26%                                                 Southwest Airlines (LUV):  -3.50%

AT&T (T):  +1.79%                                                                                    Boston Beer (SAM):  +1.16%

Eli Lilly (LLY):  +0.99%                                                                          Facebook (FB):  +8.12%

Kroger (KR):  +1.31%                                                                               Middleby Corp (MIDD):  +2.22%

SunEdison (SUNE):  -4.54%                                                                 Tractor Supply Co  (TSCO):  +1.67%

Accenture   (ACN):  -0.29%                                                                    Alexion Pharmaceuticals (ALXN):  +0.90%

Amazon  (AMZN):  +6.07%                                                                    CyberArk Software  (CYBR):  +6.70%

Ecolab  (ECL):  +1.66%                                                                             Ellie Mae  (ELLI):  +1.86%

EZchip Semiconductor (EZCH):  +8.73%                                          Occidental Petroleum (OXY):  +7.20%

Paypal Holdings  (PYPL):  +2.84%                                                       Schlumberger  (SLB):  +5.16%

Syngenta AG  (SYT):  +0.71%                                                                 Yahoo Inc   (YHOO):  +2.86%

You can tell from the list that it we purposely employed a barbell strategy to focus on (1) defensive companies that would limit downside if the market took another tumble (AT&T, Eli Lilly, Kroger, Ecolab, Boston Beer, etc.) and (2) high growth companies that had sold off greater than the market itself and would be due for a big bounce back when the market moved higher (EZchip, Paypal, Amazon, Facebook, Alexion, CyberArk, etc.).

For the most part, I am happy with how it has turned out –  the defensive stocks were up small as expected and the aggressive stocks were up big as expected.  Of the three that we have lost on, the losses are less than the market overall and there are still reasons to buy these companies at today’s levels.

Today, the market pulled back a bit under 1% which is to be expected given the past few days of big gains recovering some of the sell-off.  What’s in store for the rest of the year?  We need to watch the same things that caused us grief during August:  China, the dollar, automated trading programs, and the Federal Reserve’s threat to raise interest rates.

If the market continues higher and approaches its previous high, we will likely raise cash again.  Will it?  A lot of technical damage was done to the market during August.  Support levels were broken and investor confidence was shaken.  Believe it or not, those are good things to have happen from time to time.  It tends to shake out the weak hands and correct excesses – like the significant level of margin investing that was in place prior to the sell-off.  It also solidifies the fact that a well thought out strategy beats index investing hands down as the indices fall and there is no one there to manage the investments.

As things develop in the markets, I will be here on the blog updating you about what’s happening and what we are doing about it.  If you haven’t signed up to receive email notices of new posts, you can do that by clicking the subscribe link above.

 Mark

Automated Trading Programs

Thursday, August 27th, 2015

S&P Today

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 Just a short update today – I wanted to show you what the market action looked like.  All day long, the market trended upward until 2pm when the computers kicked in and drove it down to support (see the graph below for the blue horizontal line I drew in).  Then when it hit support, the computers started buying driving the price back up to when it started at 2pm.

s&p 500 2015-08-257

You can see where the support line is and its easy to picture how the automated trading programs were set to be buyers when the market fell to that support level at the daily highs of the past three days.

For our final visual, I thought we’d revisit the graph with the Fibonacci resistance levels which give an even clearer picture of the computerized trading.

S&P fib levels

You can see pretty clearly that in today’s action, we broke through the initial level of resistance discussed yesterday and made it up to the second resistance level where at 2pm, where the automated trading programs were set to sell so they could book the short term gains made today.  The selling commenced, driving back through the initial level of resistance that was broken through this morning, down to the support level at the highs of the previous three trading days.

I’m not quite sure what the SEC or the NYSE is going to do about these automated trading programs, but its pretty clear that something needs to happen.  The markets are supposed to be a place where price discovery is conducted between independent buyers and sellers – the current market seems to have changed the dynamic for individual investors.  Likely not for the better.

 Mark

Double Bottom? Triple Bottom?

Wednesday, August 26th, 2015

S&P 10 daysDouble Click on Graph for Full Size View

If you look at the full size view of the graph above, you will see that I’ve put a purple box around the two lows made on Monday and Tuesday.  One of the basic concepts of technical analysis is that once a market makes a low it has to retest that low and not violate it (in any material manner) – this situation is called a double bottom and provides a theoretically significant level of support for future market activity.

In my opinion, the above potentially qualifies as a double bottom subject to the index completing the second “rule”  – the first being making the low and then the retest.

But what does that really mean?  Generally, you have a fairly low risk entry point to begin to buy stocks because a floor of sorts has been put in under the price coincident with the price at the double bottom.  However, the part of the “rule” that most people ignore is that the index has to break above resistance for the double bottom to be successful.

To that end, I’ve added some resistance levels on the graph for you to check out that are based on a Fibonacci retracement of the selloff from the high where we broke above the 2100 resistance level to the lows put in the past two days.  You can see that for each of the past two days, the market approached the first resistance level and was turned away.  Today, we moved back up toward the resistance level, but buyers didn’t have enough steam to breach resistance.

That puts a Triple Bottom in play unless we manage to move above the 1957.70 resistance level.  We closed at 1943.09. just 0.75% away from resistance.

So what does all this mumbo jumbo really mean?  It means that tomorrow we would like to see the index move up and close above 1957.70 – it then needs to stay above 1957.70 for three market days or 3%  additional upside (this is my addition to the rule based upon my years in the investment business – blog readers from 2008 and 2009 heard all about it back then).  If so, the triple bottom has been taken out of play and the market then needs to move toward its next resistance level at 1985.52.

It also means that you have achieved a low risk entry point to jump back into the market.  If you are like me, you have been buying during this blood bath based upon the fundamentals (discussed the past two days on this blog).  Buying at these levels is not as low risk as waiting until you have confirmation the the double bottom has been achieved.  However, committing money in stages when there is extreme fear in the market has always worked for me in the past as long as the fundamentals for the market support it.  In this case, in my opinion, it does (I urge you to check out the past two day’s posts if you haven’t – particularly the calculation of fair market value on the S&P 500 Index from yesterday and the discussion on why this is not the start of a secular bear market like 2007/8/9 from the day before).

Mark

Up She Goes, Down She Goes

Tuesday, August 25th, 2015

S&P TodayDouble Click on Any Image for a Full Size View

It was a wild day in the market to say the least.  We were up almost 3% on the day then started to trail off, ending down 1.5%.  Tomorrow you will hear that we lost 550 points on the Dow Jones Industrial Average in the last half hour.

The market has disconnected from the fundamentals and is being whipsawed by the computers.  I reviewed the fundamentals in yesterday’s post – we were over-valued and needed to correct to bring pricing in line with earnings.  No more no less.

Today, we had a big move higher at the open on news that China had moved to flood its economy with liquidity in order to push economic growth higher.  BOOM!  Our market rocketed higher erasing much of what was lost yesterday.  Then, as the day moved on, you saw people begin to lighten up on stocks – then 3pm New York time hit and the computers kicked into gear selling lots and lots of large cap S&P stocks as well as certain small cap names that had been weak going into last weeks beginning of this move lower.

As I look at the names of companies that were sold off – Verizon down 3%?   Exelon down 7%?    EMC down 5%?    Merck down 5%?    AbbVie down 4.5%?    Monsanto down 4.5%? – it just baffles me.   Look at these names:  will we stop using our cell phones if the Fed raises interest rates by 0.25%  Will we stop using electricity if China’s economic growth slows from the projected 7% to 4%?  Will we stop Will our doctors stop writing prescriptions?  Will our farmers stop planting corn?

If China isn’t successful in stimulating their economy what is the extent of the impact directly to the US?  China accounts for only 9% of the total US exports which equates to 1.2% of U.S. GDP, meaning that if they stopped importing 100% of everything we export to them, our economy would not even go into recession.

This is clear to me that the computers were executing programs to sell to capture quick gains made after yesterday’s down day.  The fundamentals are sound enough that we should not see a secular bear market – definitely a correction but we’ve had that already in MANY stocks.

So I want to make sure we focus on the future and not the craziness happening at this moment.  So lets look at where, from a fundamental basis, the S&P 500 should be priced at right now.  In other words, what is its fair value.  To do that, lets look at a variety of ways to calculate it based upon the $115 earnings estimate for next year:

1.  The historic mean P/E for the S&P 500 is 15.55.   Using the estimated earnings for next year at this multiple, we come up with a fair value of 1,788.25

2.  If we use the Shiller P/E ( a normalized 10 year rolling P/E that can provide a better valuation) it’s mean is 16.62.  This gives us a fair value of 1,911.3

Today we closed at 1,867.08.  By my cowboy mathematics, that falls in between these two valuations albeit toward the high side.  But still within a fair value range.

Lets go for another valuation method not based upon earnings but upon asset values.

3.  The current book value per share of the S&P 500 is 729.29 giving us a price to book of 2.56.  If we use the mean historic price to book value ratio of 2.74, we get a fair value of 1,998.25

 And lets look at a final valuation method based upon sales.

4.  The current sales per share of the S&P 500 are 1,156.54 giving us a price to sales ratio of 1.66.  If we use the historic mean price to sales ratio of 1.4, we get a fair value of 1,619.15

That last one is a scary number, but since it seems to be an outlier we won’t give it as much credence as the others which are more in line.  The reason I am downgrading its importance is S&P 500 sales have been suppressed sue to the strong dollar (see yesterday’s post) which is due to the threat that the Federal Reserve would raise our interest rates.  That may or may not happen – or it may be a one and done – so the dollar’s strength is probably more than it really should be at this point.

So, lets come up with a composite of the valuations to see what a likely fair value would be.  I’ll weight them as follows:  30% P/E + 30% Shiller P/E + 30% Price to Book + 10% Price to Sales.   This composite gives us a fair value of 1,871.25 which is pretty much spot on with today’s close.

Now is not the time to panic and sell – if we go down some more, this means the market is undervalued based upon our fair value computation and you should be a buyer not a seller.  Warren Buffet has a saying that goes approximately:  be greedy when everyone else is scared and be scared when everyone else is greedy.  That applies here, there is no doubt in my mind.

I want to leave you with this last graph of the Bull and Bear market cycles since 1949:

S&P Bull & BearYou can see that the bear markets, although painful, retrace only a small portion of bull market gains.  If you want to be a seller, you sell during the bull market phase, much like we did earlier this year to raise cash in client accounts.  You don’t sell during the bear market phase because human nature makes it hard to jump back in to ride the next leg higher.  You are historically better staying in the market, enduring the few down days, and reveling in the many up days.

I am not sure what tomorrow or the next day will bring.  With the computers in charge, anything can happen.  However I feel good knowing that we are at fair value and any more selling presents a prime opportunity to outperform the market even further than we have so far – remember, you can’t catch the absolute bottom and you can’t catch the absolute top – don’t fret if you sell a few percent early and don’t if you buy a few percent early. In the short term you could be wrong but if you are in the stock market you are by definition a long term investor or you are in the wrong place with your money.

In the long run, by following this strategy, you will be better off than those invested in index funds and those that bought high and sold low.  I have 35 years of investment history that proves it.

Mark

Correction Time

Monday, August 24th, 2015

S&P 20 Yr

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Last week, the stock market had the worst week of the year, and the worst week since 2007.

Today, we open with another selloff that has blown through support at the 150 and 200 day moving averages which have acted to turn back selloffs over the past few years.

We are off about 4% as I type this, taking the S&P 500 index down 8% year-to-date.

Earlier in the year, I wrote on the blog that we were raising cash in client accounts – roughly 5% of the equity value – because the indicators I follow and the valuation metrics I use were telling me that the market had gotten to an extended level and we were due for a pullback.

S&P YTD

This graph shows you what has happened since then:  the stock market has been in an eight month sideways trading pattern, moving above the 2100 level 13 times then pulling back.  The buy-the-dippers stepped in each time and turned the decline around, pushing it back above the 2100 level.

Until this time.

So what’s different this time?  Global Deflation

Global Deflation is a secular trend driven by:

(1) Demographics- Japan, Europe, and China are all reproducing at less than replacement levels with the US roughly flat due to immigration, putting a cap on economic growth as more and more money goes to transfer payments to and medical care for an aging population instead of into economic growth;

(2) China’s economic slowdown as it transforms into a consumer economy from a producer economy, yielding a marked decrease in the need for commodities like iron, copper and petroleum;

(3) a slow growth US economy at 1.8% GDP which is less than the 2% target set by the Fed;

(4) the September target date for the Federal Reserve to raise interest rates was gaining acceptance given the strong unemployment number (at least strong to our government that doesn’t count those who have left the work force as adding to the decrease in the rate);

(5) continued economic weakness in Europe leading to reduction in the need for commodities;

(6) global debt levels have increased to an estimated $225 Trillion or roughly 300% of global GDP that puts a lid on future growth; and

(7) the likelihood that much of that debt never gets repaid – e.g., Greece, Cyprus, et. al.

In terms of valuation, the most recent quarterly results for corporate earnings were underwhelming – the strong dollar has hurt our export driven manufacturers and global corporations from two perspectives:  (1) our products are more expensive in foreign markets given the higher dollar, which lowers sales; and (2) those sales in foreign currencies are lower when translated back to dollars.

The S&P was trading at a P/E ratio of 18.25X forward earnings and has since adjusted to 16.5X forward earnings as of Friday – that obviously will be lower today, more like 16.25X forward earnings.  This gets us closer to the long-term average of 15X, but still doesn’t approach Germany, a country that is in a similar place in its business/economic cycle, that has a 14X P/E ratio.

When we are in a sell off like this, there are two things we want to know:  where will it stop and when should we buy.  To help answer that question, we need to figure out where support levels are that would cause buyers – in particular the computers who have been programmed to buy at support levels – to step in a buy the dip.

S&P 15 months

The graph above shows you a couple of those levels that go back to the October 2014 sell-off.  The graph below gives you a close-up view and I’ve circled the 1863 level on the S&P 500, which is the likeliest support level since that is where the market closed on the day that was the reversal day.

S&P 500 Oct 2014And my final graph for you is one that shows you the S&P 500’s movement today:

S&P TodayYou can see the market was in free fall at the open and went down to 1868 (right at support) – and buyers stepped in driving us up 5%.  As I type this, the market is headed back down from that level – BUT will probably bounce around all day within this range of down 8% to down 3%.  If we can close today near the top of the range, this will be a good sign.  If we close at the bottom of this range or even lower, that is a sign that tomorrow will likely be another sell off day at the open.

So what gives me some confidence that this is just a revaluation and not the start of some secular decline that will take us down like the 2008?  We do not have a financial system in crisis like we did then, like we did in 2001, like we did in 1998, like we did in 1987.  We simply have a market that got overvalued based upon investors paying more for earnings than they were worth due to the expectation that the Fed would keep rates low forever, that China would continue to be the growth engine that powered the world, and that corporate earnings could continue to grow.

So what’s my plan?  To put some cash to work and buy a few of our favorite companies that have sold off, and focus on companies that have primarily domestic exposure.  There is no way to catch the absolute bottom of any particular stock’s sell off – prudence dictates that you put money to work during the sell-off a little bit at a time.

We started to use some of our cash on Friday afternoon, buying Southwest Airlines and Cal-Maine Foods.  Southwest is an all domestic airline that should benefit from oil below $40 and Cal-Maine should benefit from consumers focusing their purchases on food staples if we have some sort of economic downturn to go along with the stock market downturn.  We will continue to put cash to work in a determined manner in companies that are significantly lower than their 52 week average – remember stock prices are all about earnings growth so we will focus on companies with growth levels higher than the market average or ones that we anticipate will be above market averages when this all shakes out.

 Mark

When Is A Correction Not A Correction?

Thursday, August 13th, 2015

BreadthDouble click on any chart for a full size view

[Apologies if you followed the link from the subscriber email to get to the blog – our developers are working on the look of it – it is functional but not stylish – you can get a better read at this link:  http://www.bankchampaign.com/marks-investment-blog]

When I want to get a visual representation of what is happening in the market beyond how the indices say the market is performing, I look at the graph above.  This is a breadth indicator I follow that reports the percentage of stocks in the S&P 500 that are trading above their 200-day moving average (the gold bars) and their 50-day moving average (the black bars superimposed over the gold bars).

I like this because at a glance I can see the trend in prices for the 500 companies in the index when they are not obscured by the weighting calculation of the index itself.

What I see above is that less than half the companies in the index are trading above their 50-day moving average and that the trend over the past six months – albeit with some definite up/down movement – is downward.   What I also see is that slightly above half the companies in the index are trading above their 200-day moving average and that the trend over the past six months is also downward.

In the graph below, you can see which markets are performing well and which are not year-to-date:

Index Performance

The NASDAQ is the big winner, followed by mid-cap stocks (2015 is the year of the Growth Stock, something I personally am enjoying since I manage our growth and aggressive growth investment strategies).  The S&P 500 is up just over 1% – but the telling performance is of the Dividend Stocks and the Blue Chips (as represented by the Dow Jones Industrial Average).

Over the past few years, investors have flooded into the Dividend Paying Stocks, of which the Blue Chips are are major component, because bonds and CD’s pay so little in interest.  The Dividend Stock Index has a 3.21% yield, significantly higher than the 0.71% yield on a two-year treasury or similar term CD.

Investors who have flooded into these dividend paying stocks for the cash flow they provide see that even though the news is reporting the stock market is up on the year (remember the S&P 500 is up roughly 1%) they are down 2% to 5% year-to-date – and maybe a heck of a lot more if they loaded up on >4% yielding energy stocks.

Take a look at some of the economic sectors where the dividend paying stocks are concentrated:

Sector PerformanceUtilities are down almost 4%; Industrials are down almost 5%; and Energy companies are down almost 13%.

The Health Care sector appears to be a winner for dividend investors, but that +9% YTD return is skewed by the performance of the biotech sector, up +22% YTD.   Traditional health care dividend investments, like Johnson & Johnson (down 5% YTD), Bristol Myers (up 6% YTD) and Merck (up 5% YTD) are not performing as well – the exceptions are Pfizer and Lilly, both up double digits due primarily to their biotech exposure.

Yes, the news is reporting that the stock market is up.  But if you are a typical investor who only has eyes for blue chip dividend stocks, you are feeling some pain in 2015.

Mark