Disciplined Approach to Investing

Taxing Stock Trades Gets Closer

2009-11-24T22:59:00.000-05:00

As I have noted in several posts in the recent past, Congress is getting closer to taxing certain securities transactions. The bill proposes a .25 percent tax on the sale and purchase of financial instruments such as stocks, options, derivatives and futures. Half of the proceeds would go to reduce the deficit and the other half of the proceeds from the tax would be used to create jobs. Retirement accounts would be exempt from the tax. Unions, such as the AFL-CIO and SEIU are in favor of the tax since they believe the tax will not have an impact on the average investor.

Who does Congress and the unions believe will pay the tax? The tax will be passed on to all investors. It's just like saying a company pays taxes. Companies do not pay taxes, they collect them and pass them on to the government. The taxes become a component of the cost of business that is passed on to the end consumer. The Congress and White House need to cut spending. Higher taxes do not stimulate job creation.

The recent actions out of Congress do not surprise me given the lack of business experience in President Obama's cabinet.

Chart Source: InfectiousGreed

Carry Trade Risk Might Be Overstated

2009-11-22T17:06:00.000-05:00

In early November Nouriel Roubini wrote in the Financial Times that the Mother of all carry trades faces an inevitable bust. Roubini states the rise in risky asset values: equities, high yield bonds, etc. has been driven by the carry trade with the U.S. Dollar.

"Roubini states, so what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fueling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions."

David Rosenberg, Chief Economist & Strategist for Gluskin Shelf, recently weighed in on the carry trade as well.

"The U.S. dollar has become a huge ‘carry trade’ vehicle for all risky assets. Historically, there is no correlation at all between the DXY index (the U.S. dollar index) and the S&P 500. In the past eight months, that correlation is 90%. Ditto for credit spreads — zero correlation from 1995 to 2008, but now it has surged to 90% since April. There was historically a 70% inverse correlation between the U.S. dollar and emerging markets, such as the Brazilian Bovespa, and that correlation has also increased to 90% since the spring. Even the VIX index, which historically has had no better than a 20% correlation with the U.S. dollar, has now sent that correlation surge to 90%. Amazing. The inverse correlations between the U.S. dollar and gold and the U.S. dollar and commodities were always strong, but these too have strengthened and now stand at over 90%."

The reason for the heightened focus on the carry trade is because when it is unwound, negative shocks can inflict risky assets and weak currency economies. Earlier this year, this type of shock inflicted Latvia and other Eastern and Central European economies. Does the data really support this carry trade risk though?

According to Larry Hathewey, an economist at UBS, in a report dated November 12, 2009, data on leverage and financial flows do not support the assertion that gains in global equity, credit, or most commodity prices have been primarily driven by leverage and liquidity. Hatheway indicates that margin debt and stock market volumes should be higher for the carry trade to be leading to bubles in these riskier asset investments. In fact the opposite is true.

Source: The Globe and Mail

According to an article in the Globe and Mail, Dr. Doom, borrowing and bubbles,

"If a ‘speculative bubble' were driving equity prices higher, presumably volumes would reflect the exuberance,” Mr. Hatheway said. “Yet average daily trading volume on the New York Stock Exchange has been declining since 2005, reversing the strong trend growth over the previous decade."

There is one bubble that is worth noting, UBS suggested. As the price of gold has increased, so too has derivative volumes."

"There, soaring prices have coincided with an increase in derivatives volumes. That squares with our view that what is driving gold prices is not a supply-demand imbalance in the physical market, but rather an increase in financial demand, he said.

"Gold prices and derivatives activity, in other words, show signs of a market driven by financial demand, either for hedging or speculative purposes. But what's notable is that gold is unique – equity, credit and even government bond markets do not show evidence of a similar pick up in derivatives activity."

The U.S. is not the only country whose currency continues to weaken. In Japan, the BOJ has its target interest rate near zero as well. In Q3, Japan's nominal GDP fell at a .3% rate due to continued price weakness and seems unable to shake off deflation. This lower rate in Japan will put downward pressure on the Yen, thus providing another currency for the carry trade.

In the end though, I believe Larry Hatheway points to important data that indicates the carry trade may not be fueling this global market melt up. As Hatheway noted in his research report,

"we (UBS) believe price gains largely reflect improved fundamentals, including signs of global economic recovery, the strength of emerging economies, and a recovery of earnings. Financial market activity—including the size of the financial sector as well as funds flows and derivatives activity—remains subdued by historical standards."

"Until leverage resumes market outcomes will be driven mostly by growth and earnings expectations. Importantly, as well, uncertainty about monetary policy 'exit strategies' is likely to boost market volatility next year. And with many asset classes now close to 'fair value', risk-adjusted returns are likely to be lower in the year to come."

H/T: pazzomundo.com

A Contrarian Money Manager's Case For A Slower Growing U.S. Economy

2009-11-22T14:29:00.000-05:00

Much has been made recently about the U.S. Dollar and its use in the carry trade. Consuelo Mack of WealthTrack recently interviewed Robert Kleinschmidt, President and Chief Investment Officer of Tocqueville Asset Management and portfolio manager of the Tocqueville Fund. In the below video, Kleinschmidt discusses where his contrarian investment philosophy is leading him now and why investors should be concerned about U.S. government debt and the future of the dollar.

Kleinschmidt believes the government's action of bailing out AIG, TARP etc., actually contributed to and worsened the global financial crisis. He also believes the U.S.'s actions have jeopardized the dollar's status as the world's reserve currency. Lastly, Kleinschmidt believes the U.S. economy will look more like a European one where growth is in the 1-2% range and results in unemployment remaining in the 10% range for the foreseeable future.

Investor Bullish Sentiment Above Long Term Average

2009-11-19T22:22:00.000-05:00

Today's investor sentiment as reported by the American Association of Individual Investors shows bullish sentiment increased to 42.73% compared to last week's reading of 38.60%. This week's bullishness level is above the long term average of 39% but remains below the +1 standard deviation level of 50%. The bull/bear spread came in at a +11% versus last weeks 0%.

(click graph for large chart)

Fixated On The VIX

2009-11-18T18:45:00.000-05:00

Seems a day does not go by that a market commentator can't resist mentioning the low level of the VIX and the potential implication for the market's future direction. The reason this fear index is in the news is low levels of the VIX tend to be a signal of a market top. I wrote a post in October of last year titled, What is the VIX Index, that provides background on this market measure.

Many commentators are suggesting that the current current level of the VIX, 21.8, is one reason to be skeptical of the current level of the stock market. Certainly the +50% advance off of the March low is reason to be cautious; however, the current level of the VIX doesn't necessarily indicate a market correction is around the corner. As the below chart notes, during the mid 1990's and early 2007, the VIX reached a level near 10.

So just because the VIX is near 20, this does not necessarily foretell a market correction around the corner.

Sysco Corp Increases Dividend 4.1%

2009-11-17T22:26:00.001-05:00

Sysco Corp. (SYY) announced the company is increasing its fiscal 3rd quarter 2010 dividend by 4.17% to 25 cents per share. This compares to 24 cents per share paid in the same quarter last year. The company has increased its dividend in each of the 40 years it has been trading as a public company.

The estimated payout ratio will equal 48% based on 6/2010 estimated earnings of $1.89. This compares to the 5-year average payout ratio of approximately 53%.
The company carries an S&P Earnings & Dividend Quality Ranking of A+.

(Disclosure: Long SYY)

Intel and Lancaster Colony Increase Dividends

2009-11-17T21:46:00.003-05:00

Catching up after some dividend increases this week.

Intel

On Monday, Intel Corp. (INTC) announced the company is increasing its 1st quarter 2010 dividend by 12.5% to 15.75 cents per share. This is Intel's first quarterly dividend increase since the second quarter of 2008 when the company increased the quarterly dividend to 14 cents per share.

The estimated payout ratio will equal 43% based on 12/2010 estimated earnings of $1.46. This compares to the 5-year average payout ratio of approximately 36%.
The company carries an S&P Earnings & Dividend Quality Ranking of B+.

Lancaster Colony

Today, Lancaster Colony (LANC) announced the company is increasing its fiscal 2nd quarter dividend 5.26% to 30 cents per share. This compares to 28.5 cents per share paid in the same quarter last year.

The estimated payout ratio will equal 33% based on June 2010 estimated earnings of $3.68. The reported earnings for the year ending June 2009 equaled $3.18.
The company has an S&P Dividend & Earnings Quality Ranking of B.

(Disclosure: Long INTC)

Bullish Investor Sentiment Increases But Below Long Term Average

2009-11-15T11:00:00.000-05:00

This past week's American Association of Individual Investors bullish sentiment reading saw an increase to 38.6% versus last week's reading of 22.2%. The long term average of the bullish sentiment level is 39% so the reading remains below this longer term trend. The 8-period moving average of the reading declined to 37.5% from 37.9% last week and is the fourth straight week the 8-period average has declined. The bull/bear spread came in at a flat 0%.

For contrarians, individual investors seem to remain cautious about the future direction of the market. Guy Lerner of the Technical Take website notes the so called "smart money" indicator has turned bearish. Guy notes the "smart money" tends to get the trends right, while the "dumb money" does not. We will see. If we could break resistance of 1,100 on the S&P 500 Index, a further move higher in the market through year end is possible.

Watching Consumer Confidence

2009-11-14T10:09:00.002-05:00

As I noted in an earlier post on March 9th of this year, consumer confidence tends to lag the stock market by about 2-3 months. The Conference Board's consumer confidence index reported its second monthly decline at the end of October. Since the confidence index tends to lag the market by several months, it is not surprising to see this confidence drop in October. October was a down month for the S&P 500 Index with the index closing at 1,036 versus September's close of 1,057.

Friday's preliminary release of the Reuters - University of Michigan Surveys of Consumers similarly saw an October decline in confidence as well to 69.4 versus September's 73.5. One positive is the S&P 500 Index is up 5.66% so far in November. A big negative impacting confidence is the level of the unemployment rate at 10.2% and seemingly continuing to move higher.

As the below chart of the S&P 500 Index shows, the market is struggling to break resistance at the 1,100 level. The weak attempt to move through this 1,100 level is evidenced by the declining volume.

The White House and Congress may finally be seeing that its spending binge is weighing on the market and consumers. A recent article on Politico notes the White House may focus on deficits "after voting for the stimulus, the bailouts, the health care legislation and a plan to address global warming, four enormous government programs. Obama has spent more money on new programs in nine months than Bill Clinton did in eight years, pushing the annual deficit to $1.4 trillion. This leaves little room for big spending initiatives." Let's only hope so.

Money Market Cash: Fuel For The Fire

2009-11-10T22:32:00.000-05:00

Investor cash on the sidelines could serve as a source of funds for additional stock purchases and a continued move higher in the market averages. As the below chart shows, cash levels remain higher than the 27% reached during the 2001-2002 recession and far above the 16% historical average.

From Disciplined Approach to Investing

If one includes ultra short and short term bond fund investments, potential liquidity that could find its way into stocks is significant. In short, investors do not believe this rally is sustainable and that is music to a contrarian's ears.

Source:

Still High Cash Levels May Provide Further Support For Stocks (PDF)
Fidelity's Market Analysis, Research and Education
October 22, 2009
http://personal.fidelity.com/products/funds/content/pdf/MARE-Fuel-For-Stocks.pdf

Unemployment Rate Above 10%, Only Second Time Since WWII

2009-11-06T13:44:00.000-05:00

Today's Labor Department report that the unemployment rate rose to 10.2% is only the second time it has crossed the 10% threshold since the post World War II period. Today's unemployment rate represents a 26-year high for this indicator.

According to Chart of the Day, "it is also worth noting that the unemployment rate has tended to peak shortly after the end of the recession. Following the previous two recessions, however, the unemployment rate kept rising for many months following the beginning of an economic 'expansion.'"

Small Cap Relative Valuations Look Stretched

2009-11-05T23:59:00.000-05:00

Historically, small cap stock returns coming out of a bear market have outperformed large cap stocks. The performance of small caps relative to large caps since the March 9th lows has been no different. The small cap outperformance tends to run for a period of around two years.

(click to enlarge)

However, this might not be the case in this market cycle. The difference this time is the relative valuations of small caps look the most stretched going back to 1983. Given the valuation gap between small and large, it appears large caps might be the better asset class at this point in the cycle.

(click to enlarge)

One factor that may serve as a tailwind for large cap stock outperformance is the fact many large companies generate significant amounts of revenue from foreign sources. With the U.S. Dollar weakening, the conversion of foreign earnings into the dollar will provide a boost to earnings growth near term. Additionally, the developing market countries are experiencing better economic growth, thus a benefit to the large multinational companies.

Source:

The Market Recovery and Outlook for Small-Cap Stocks (PDF)
T.Rowe Price Report
By: Jack LaPorte
Fall 2009
http://individual.troweprice.com/staticFiles/Retail/Shared/PDFs/PriceReports/Fall2009PriceReport.pdf

Bullish Investor Sentiment In Freefall

2009-11-05T22:15:00.000-05:00

This week's bullish investor sentiment reported by the American Association of Individual Investors took a dramatic slide to the downside. The bullish sentiment reading fell 11.4 percentage points to 22.22% from last week's reading of 33.65%. This week's reading is the lowest since March 5th's bullishness reading of 18.92%. The bull bear spread widened to -33% compared to last weeks spread of -9%.

(click to enlarge)

When looking at the 8-period moving average of the sentiment at 37.94%, the decline is not so significant though. In the February-March 2008 time frame, the 8-period average was in the mid 20% range for six weeks. Nonetheless, investors seem to be doubtful of future market advances. As this is a contrary indicator, it is one factor that suggests the market could advance further over the next six months. Today's 200 point or 2% advance on the Dow Jones Index is a good start.

Dividend Aristocrats Performance Update

2009-11-04T19:44:00.000-05:00

It seems it has been some time since I updated the performance of Standard & Poor's Dividend Aristocrats. Year to date through November 4, 2009, the Aristocrats have generated a better return than the Dow Jones Industrial Index, 12.2% versus 11.7%, respectively. However, the Aristocrats performance has trailed the return on the S & P 500 Index's return of 15.9%.

In the below table, I have shaded the rows for those companies that have cut their dividend this year.

Full View

Dividend Payers Outperform Non Payers In October

2009-11-02T21:26:00.000-05:00

October was a down month for the S&P 500 Index seeing the index decline 1.87%. During the month, the dividend payers finally did outperform the non payers, -2.3% versus -6.2%, respectively. This is the first time payers have outperformed the non payers this year. On a year to date and 12-month time frame, the non payers continue to maintain a significantly higher return than the dividend payers.

Source: Standard & Poor's (xls)

Howard Silverblatt, Senior Index Analyst for Standard & Poor's notes in the October Monthly Market Attributes Report:

From March 9th, the 165 trading days produced a 53.16% gain for the S&P 500, which is the best gain since the 53.76% increase in October 1938.
While the market remains 33.80% off its 2007 high, the gains have mostly stayed with little profit taking and few major selling days.
Volatility picked up during October and continues to remain higher than historical values, although lower than the first half of 2009. Year-to-date, there have now been more days where the S&P 500 moved less than 1% than more than 1%. However, the swings have also been fewer and less drastic. The last 5% move was on March 23rd (+7.08%), with the last 3% move occurring on June 22nd (-3.06%).

If the easy money has been made with strong performance from the higher risk, lower quality stocks, the market may be entering a period where the higher quality dividend growers begin to outperform the non payers over an extended period of time.

Market Looks Oversold

2009-11-01T23:52:00.003-05:00

In looking at the percentage of S&P 500 Index stocks trading above their 50 day moving average, the market looks to be near a short term oversold position.

In looking at the 150 day moving average, 80% of S&P 500 stocks are trading above the 150 day M.A. This is down from 97% in September.

A Piotroski Low Price To Book Stock: Highway Holdings Ltd.

2009-11-01T11:44:00.000-05:00

One of the American Association of Individual Investors' better performing stock screens over the long run is the Piotroski Price to Book Screen.

Of late the number of companies passing the screen's criteria has been slim to none. The criteria of the screen are:

The price-to-book ratio ranks in the lowest 20% of the entire Stock Investor AAII database.
The stock does not trade on the over-the-counter exchange.

The return on assets for the last fiscal year (Y1) is positive.
Cash from operations for the last fiscal year (Y1) is positive.

The return on assets ratio for the last fiscal year (Y1) is greater than the return on assets ratio for the fiscal year two years ago (Y2).
Cash from operations for the last fiscal year (Y1) is greater than income after taxes for the last fiscal year (Y1).

The long-term debt to assets ratio for the last fiscal year (Y1) is less than the long-term debt to assets ratio for the fiscal year two years ago (Y2).
The current ratio for the last fiscal year (Y1) is greater than the current ratio for the fiscal year two years ago (Y2).

The average shares outstanding for the last fiscal year (Y1) is less than or equal to the average number of shares outstanding for the fiscal year two years ago (Y2).
The gross margin for the last fiscal year (Y1) is greater than the gross margin for the fiscal year two years ago (Y2)

The asset turnover for the last fiscal year (Y1) is greater than the asset turnover for the fiscal year two years ago (Y2).

Currently, only one company out of AAII's database of companies passes the screening criteria. The company is a Hong Kong based company, Highway Holdings Ltd. (HIHO) and trades on the NasdaqCM exchange.

Investors are highly encouraged to fully research any company mentioned before purchasing. In the case of HIHO, it is a small company trading at a stock price below $5 per share. The stock's market capitalization is $6.1 million. These below $5 stocks are typically very volatile investments.

James Grant Interview On WealthTrack: Believes Strong Recovery Ahead

2009-11-01T09:01:00.003-05:00

Consuelo Mack of WealthTrack interviews James Grant, Editor of Grant's Interest Rate Observer. By nature, James Grant is a glass is half empty type of person, yet he believes the economy will surprise to the upside and be surprisingly strong.

In the interview, Grant cites a quote from English economist, A.C. Pigou,

"The error of optimism dies in the crisis but in dying it ‘gives birth to an error of pessimism. This new error is born, not an infant, but a giant; for (the) boom has necessarily been a period of strong emotional excitement, and an excited man passes from one form of excitement to another more rapidly than he passes to quiescence.’"

One other noteworthy piece of advice to investors is that Wall Street is not an investors friend. Investors should buy investments not when they feel good, but when they feel the worst about a particular investment.

The interview is a worthwhile one that investors should view.

Stryker Increases Dividend 50%

2009-10-31T09:14:00.000-04:00

Yesterday Stryker Corp. (SYK) announced the company's dividend payment would be transitioned to a quarterly dividend from an annual one. In order to accommodate this change, SYK will pay a 10 cent fourth quarter dividend for 2009.

This will bring total 2009 dividends to 50 cents per share versus 33 cents per share paid in 2008. This represents a 51% increase in the dividend on a year over year basis.

Further, the company will begin paying a 15 cent per share quarterly dividend beginning in the first quarter of 2010. If the 2009 dividend is spread over four quarters (12.5 cents per quarter), the 2010 quarterly dividend will represent a 20% increase over the 2009 estimated quarterly dividend.

The payout ratio based on estimated 2009 earnings per share of $2.94 will be about 17%.

The company has an S&P Earnings & Dividend Quality Ranking of A+.

Bullish Sentiment At Lowest Level Since July 16th

2009-10-29T22:22:00.000-04:00

This week's release of bullish investor sentiment by the American Association of Individual Investors shows bullish sentiment fell to 33.65%. This is the lowest level for the bullishness reading since the bullishness reading was reported at 28.68% for the week of July 16, 2009. The eight period moving average fell slightly to 39.83% versus the prior week's average of 40.37%.

Individual investors do not appear to have reached the overly bullish state as of yet.

Supervalu Cuts Dividend

2009-10-26T20:14:00.001-04:00

Catching up after some travel.

Last week Dividend Aristocrat Supervalu (SVU) cut the company's dividend by 50%. SVU becomes the first consumer staples stock to reduce its dividend.

The new quarterly dividend is reduced to 8.75% from 17.5%.

The company's second quarter earnings came in at 35 cents per share versus 61 cents per share in the same quarter last year.

Full year earnings for February 2010 are estimated to come in at $1.94 and February 2011 earnings are projected at $2.01.

(click to enlarge)

Fund Flows During And After The Crisis

2009-10-25T18:48:00.002-04:00

Investors who stuck with equity investments (S&P 500 Index) in October 2008 and through the March 2009 sell off would now be up 9% from October 2008 through August 2009. Many investors liquidated equity investments in October and again in March.

Investors withdrew $70 billion from the stock market in October 2008 and another $50 billion in the February/March 2009 period.
As of October 16, 2009, one year after the peak in liquidations, investors who remained in the stock market had fared better than those who exited at the peak of the crisis and stayed on the sidelines.

One implication for investors as it relates to this data is the difficulty in trying to time the market. For investors, focusing on high quality dividend growth stocks provides the potential to minimize the downside volatility in the equity portion of ones portfolio.

Source:

Stay-the-Course Ahead of Panic Sellers
By: Fidelity's Market Analysis, Research, & Education Group
October 23, 2009
http://publications.fidelity.com/investorsWeekly/investorsWeekly/cms/IW0910crisis.dyn

Economic Activity Picking Up?

2009-10-23T18:09:00.001-04:00

As readers may have noticed from the limited number of posts to my blog this week, I was away from the computer due to some out of town travel. I traveled by car from Ohio to Florida on I-75. Along with my travel companion, we both commented on the number of semi trucks that were traveling the highway. The parking lots at a couple of truck stops we passed were packed full with semis. Even several of the rest areas were packed with semis. I am guessing all these trucks were not traveling with empty loads. At a minimum, I think the economy is experiencing some inventory restocking activity and possibly a pick up in consumer demand.

Tax and Spend

2009-10-23T17:53:00.000-04:00

As I have noted in several earlier posts, Congress is looking to place a tax on stock trades. They have not given up on this trading tax as noted by the below screen shot from my Site Meter account.

(click to enlarge)

Correlations Have Increased

2009-10-17T19:55:00.000-04:00

Investors are often advised to spread their investments across differing asset classes because of the lower correlation of these other asset classes. Unfortunately, the correlation of many of these other asset classes has continued to increase.

I have discussed this issue of higher correlation in earlier posts:

Diversification and Correlation During Market Crisis Periods

Global Equity Market Correlations Continue To Increase

Fidelity's Market Analysis, Research and Education (MARE) group recently updated correlation data as of August 31, 2009. As the below table notes, correlation versus the S&P 500 Index has increased across a number of asset classes except U.S. Government Bonds.

MARE notes the potential investment implications:

U.S. government bonds performed very well as riskier assets tumbled during the financial crisis in 2008, but so far in 2009 have fared poorly as riskier assets have rallied amid signs of economic stabilization and improvement.
There are potential scenarios where U.S. bonds could either hold up well in the months ahead (a double-dip recession, further financial system turmoil, etc.) or underperform riskier assets (rising inflation, increased concerns about the U.S. fiscal deficit/creditworthiness, or a better-than-expected economic recovery).
It remains to be seen whether the recent increase in correlations among riskier assets will define a new, more highly correlated era. In any case, investors are likely to be on safer ground anticipating that U.S. government bonds will continue to be one of the few ways to effectively diversify a portfolio.

In the end, investors need to be aware of this move towards higher correlation across a number of asset classes. Simply spreading ones investments into various asset classes will not necessarily ensure a higher risk adjusted return.

Source:

Where To Find Diversification In A Highly Correlated World (PDF)
Fidelity (MARE)
September 21, 2009
http://personal.fidelity.com/products/funds/content/pdf/where-to-find-diversification.pdf