Tag Archives: gary-gordon

Lack Of Earnings Quality And Debt Downgrades Limit S&P 500’s Upside

Four in a row. That’s how many consecutive 3-point baskets Andre Iguodala scored against the Houston Rockets in last night’s playoff game. There has also been a “4 for 4″ in the financial markets. One after another, major banks have lowered their year-end targets for the S&P 500. Most recently, the global equity team at HSBC shaved its year-end target to 2,050 from 2,100. On the surface, HSBC’s cut is less severe than other bank revisions to S&P 500 estimates. That said, J.P Morgan pulled its projection all the way down from 2200 to 2000. Credit Suisse? Down to 2,050 from 2,200. And Morgan Stanley slashed its year-end projection from 2175 to 2050. So what’s going on? We had four influential banks expressing confidence in the popular benchmark a few months earlier. Their analysts originally projected total returns with reinvested dividends between 5%-10% in the present 12-month period. Now, however, with the S&P 500 only expected to finish between 2000-2050, these banks see the index offering a paltry 0%-2%. Another way some have phrased it? Excluding dividends, there is “zero upside.” Here is yet another “4 for 4” that makes a number of analysts uncomfortable. Year-over-year quarterly earnings have fallen four consecutive times. That has not happened since the Great Recession. And revenue? Corporations have put forward year-over-year declines in sales growth for five consecutive quarters. That hasn’t happened since the Great Recession either. The bullish investor case is that the trend is going to start reversing itself in the 2nd half of 2016. However, forward estimates of earnings growth and revenue growth are routinely lowered so that two-thirds or more companies can surpass “expectations.” And it is not unusual for estimates to be lowered by 10%. Take Q1. Shortly before the start of the year, Q1 estimates had been forecast to come in at a mild gain. Today? We’re looking at -9% or worse for Q1. Over the previous five years, Forward P/Es averaged 14.5. They now average 16.5 on earning estimates that will never be realized. In essence, S&P 500 stock prices are sitting a softball’s throw away from an all-time record (2130), while the forward P/E valuations sit at bull market extremes that do not justify additional appreciation in price. And what about earnings quality? Wall Street typically presents two kinds: Generally Accepted Accounting Principles (GAAP) earnings and non-GAAP earnings that excludes special items, non-recurring expenses and a wide variety on “one-time charges.” The foolishness of non-GAAP presentations notwithstanding, one might disregard the manipulation when non-GAAP and GAAP are within the usual 10% range. This was more or less the case between 2009 and 2013. By 2014, however, the gap between the two different earnings per share reports began to widen. By 2015, “manipulated” pro forma ex-items earnings exceeded actual earnings per share by roughly $250 billion, or 32%. Can you spell c-h-i-c-a-n-e-r-y? Of particular interest, there was a similar disconnect between GAAP and non-GAAP in 2007. Non-GAAP in the year when the last bear market began (10/07) was 24% higher than GAAP earnings per share. It follows that the discrepancy today in earnings quality is even wider than it was prior to the stock market collapse. “But Gary,” you protest. “As long as the Federal Reserve and central banks are exceptionally accommodating, stocks should excel.” In truth, however, the long-term relationship between the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) and the Vanguard Total Bond Market ETF (NYSEARCA: BND ) demonstrate that the bond component of one’s portfolio has been more productive over the last 12 months than the stock component. Bulls can point to the market’s eventual ability to shake off the euro-zone crisis of 2011. That was the last time that the SPY:BND price ratio struggled for an extended length of time. Back then, however, the Federal Reserve offered two aggressive easing policies – “Operation Twist” and “QE 3.” Today? Stocks are not only extremely overvalued on most historical measures, but the Fed has only lowered its tightening guidance from four hikes down to two hikes. Is that really enough ammunition to power stocks to remarkable new heights? “Okay,” you acknowledge. “But rates are so low, they are even lower than they were in 2013. And that means, going forward, there is no alternative to stocks.” Not only does history dispel the myth that there are no alternatives to stocks , but many corporations that have been buying back their stocks at attractive borrowing costs are now at risk of debt downgrades, higher interest expenses and even default. For example, the moving 12-month sum of Moody’s debt downgrades hopped from 32 a year ago to 61 in March of 2016. Meanwhile, the longer-term trend for the widening of credit spreads between investment grade treasuries in the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) and high yield bonds in the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) suggest that the corporate debt binge may soon come to an ignominious end. Foreign stocks, emerging market stocks as well as high yield bonds all hit their cyclical tops in mid-2014, when the credit spreads were remarkably narrow. The IEF:HYG price ratio spikes and breakdowns notwithstanding, the general trend for 18-plus months has been less favorable to lower-rated corporate borrowers. The implication? With corporate credit conditions worsening at the fastest pace since the financial crisis , companies may be forced to slow or abandon stock share buybacks. What group of buyers will pick up the slack when valuation extremes meet fewer stock buybacks? Click here for Gary’s latest podcast. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Low Interest Rates Alone Cannot Prevent A Bear Market In Stocks

The most common definition of a bear market in stocks? A major index needs to fall 20% from a high watermark. And while that is precisely what has happened for most gauges of stock health – MSCI All-Country World Index, Nikkei 225, STOXX Europe 600, Shanghai Composite, U.S. Russell 2000, U.S. Value Line Composite – the Dow and the S&P 500 remain defiant. Yet, there’s another way to view bulls and bears. In particular, chart-watchers often use the slope of a benchmark’s long-term moving average. It is a bull market when the 200-day moving average is rising. During these times, investors often benefit when they buy the dips. In contrast, when the 200-day is sloping downwards, it may be a “Grizzly.” During these days, investors successfully preserve capital when they raise cash by selling into rallies. There’s more. During stock bears, stocks frequently hit “lower highs” and “lower lows.” That’s exactly what investors have experienced since May of 2015. There’s little doubt that – at the moment – we are witnessing the “rolling over” of the 200-day moving average. The exceptionally popular measure of market direction is sloping downward, giving support to the notion that a bearish downtrend is in command. Technical analysis notwithstanding, there are other reasons to believe that the stock bear will maul and mangle. Fundamental analysts note that the Q1 2016 S&P 500 earnings are set to record a decline of -8.0%. That is going to register a fourth consecutive quarter for year-over-year declines in corporate earnings per share – the first such sequence since 2008 (Q1, Q2, Q3, Q4). “But Gary,” you protest. “It’s only the energy companies. You should just exclude them from consideration.” (Like technology in 2000? Financials in 2008?). Actually, it’s not just the energy sector. Seven of the 10 key economic sectors will serve up profits-per-share disappointments. Telecom, healthcare and consumer discretionary companies may be the only sectors to provide a positive boost in the upcoming earnings season. Still, get a gander at the earnings expectations at the start of the year vs. the earnings expectations at the beginning of March. It only took two months for analysts to lower their expectations for every single stock segment – percentage revisions that have not dropped this fast since the Great Recession. Keep in mind, reported earnings for the S&P 500 peaked at $105.96 on 9/30/2014. At that time, the S&P 500 closed at 1,972 and traded at a P/E of 18.6. With the most recent 12/30/2015 S&P 500 earnings at $86.46, and the 3/8/2016 close of 1979, the market trades at a P/E of 22.9. That’s correct. The market is essentially flat since September of 2014, but it is far more expensive in March of 2016 . Nearly 20% more expensive since profits peaked . It is exceptionally difficult to make a case for the overall market to be “attractive” or “fairly valued.” Not that perma-bulls haven’t tried. The most common argument is the attractiveness of stocks relative to the alternatives in fixed income. Ultra-low interest rates not only force savers into equities, they argue, but it also primes the pump for companies to buy back shares of their own stock through the issuance of corporate debt. However, history has a similar circumstance when the U.S. had a low rate environment for nearly 20 years (i.e., 1935-1954). In that period, valuations were about HALF of what they are today. If low rates alone weren’t enough to DOUBLE the “P” relative to the “E,” why are low rates enough to justify higher stock prices regardless of valuations in 2016? When top-line sales and bottom-line earnings are contracting? It is also worth noting that low rates alone did not stop bear markets occurring in 1937-1938 (-49.1%), 1938-1939 (-23.3%), 1939-1942 (-40.4%), or 1946-1947 (-23.2%). Click to enlarge By way of review, the technical picture is inhospitable. The fundamental backdrop is unsavory. And even the perma-bull panacea of low interest rates cannot obliterate historical comparisons entirely. “Well, Gary,” you decry. “Back then, we were still coming out of the Great Depression. We don’t have anything like that right now… and we are not going into recession.” I’m glad that you brought up the Great Depression. For starters, Federal Reserve policy error in 1937-1938 went a long way toward reigniting recessionary forces – dynamics not unlike the depression-like disaster that plagued America from 1929 to 1932. Today, six-and-a-half years removed from the Great Recession, Fed policy error (December 2015) remains a distinct possibility. Members of the Fed’s Open Market Committee currently believe that they can raise borrowing costs in 2016 without reversing the Fed’s wealth effect ambitions . They may learn, however, that they will be returning the country to zero percent rate policy (ZIRP) and quantitative easing (QE) to squelch a 20%-plus decline in key barometers like the S&P 500. What’s more, the stock bears in 1939-1942 (-40.4%) and in 1946-1947 (-23.2%) are not attributable to recessions or the Great Depression. Those stock bears had low interest rates and booming economies. Is the U.S. economy booming right now? The surprising popularity of anti-incumbent candidates like Sanders and Trump suggests that the real economy – jobs included – is shaky at best. This simple chart that plots both manufacturing and non-manufacturing (services) demonstrates that economic weakness is an actuality, not a doom-n-gloom delusion. One might even choose to consider the most recent business headlines. Chinese exports plummeted by their largest amount since 2009. The International Monetary Fund (IMF) warned today that the world is looking at an increasing “risk of economic derailment.” And stateside, the NFIB’s Small Business Optimism Index fell for the fourth time in five months. It now sits at its lowest level in two years while demonstrating its steepest peak to trough drop since 2009. Instead of getting more stimulus from the U.S. Federal Reserve, like “Twist” and “QE3,” the Fed is pushing “gradual stimulus removal. ” In sum, the rallies of September-October (2015) and February-March (2016) share more in common with bear market bounces than buy-the-dip opportunities. Technicals, fundamentals, economics and Federal Reserve policy collectively favor a lower-than-usual allocation to risk. For my moderate growth-and-income clients, our 45-50% allocation to domestic large caps exists in stark contrast to 65-70% in a broadly diversified equity mix (e.g., large, small, foreign, emerging, etc.). Some of our core positions? The Vanguard High Dividend Yield ETF (NYSEARCA: VYM ), the iShares S&P 100 ETF (NYSEARCA: OEF ) and the iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ). We have pure beta exposure to the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) as well. On the income side of the ledger? We have benefited immensely from a commitment to investment-grade holdings, including the Vanguard Long-Term Corporate Bond Index ETF (NASDAQ: VCLT ), the iShares 3-7 Year Treasury Bond ETF (NYSEARCA: IEI ) and munis via the SPDR Nuveen Barclays Muni Bond ETF (NYSEARCA: TFI ). For Gary’s latest podcast, click here . Disclosure : Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Damage Control: Is It Too Late Too Become More Defensive?

A manufacturing recession doesn’t matter… until it does. Consider industrial production. For the third straight month, industrial production, which includes mining, utilities, as well as manufacturing, contracted. How anemic is American industry right now? The year-over-year percentage change provides a helpful snapshot of the weakness. Not surprisingly, media mega-stars routinely dismiss manufacturers, miners and utility providers as relics of yesterday’s economy. They maintain that consumers are the only ones who count in a consumption-based society. The erosion of the high-paying careers in those segments notwithstanding, might the rosy projections for household consumption be misleading? After all, retail sales (ex auto) pulled back 0.1% in December, even as economists anticipated 0.2% growth. We can look at consumer trends in a variety of ways. As I pointed out in my most recent commentary (1/12/16), year-over-year percent growth in personal consumption expenditures (PCE) has been declining steadily for roughly 18 months. Meanwhile, year-over-year percentage changes in retail sales (ex auto) emulate what is taking place in American industry. So what happened to the “clear-cut” benefit of lower oil prices? Weren’t they supposed to be a giant tax cut for the American consumer, prompting them to spend? Not when wage growth is tepid. And not when many households have chosen to increase their savings. It should not go unnoticed that the S&P SPDR Retail Index has quickly descended into bear territory. The SPDR S&P Retail ETF (NYSEARCA: XRT ) is currently down about 22.3%. Even more disheartening for those who had not become more defensive in their asset allocation over the past year? The price of XRT is lower than it was two years ago. Ironically enough, the question is no longer whether U.S. stocks have entered a bear market in the same way that the retail segment has. Indeed, Bespoke Research already demonstrated that the average large-company stock, the average mid-sized company stock and the average small-company stock have all surpassed the 20% bear market threshold. In the same vein, the median stock in the Russell 3000 and the Value Line Index show the same. The only question now is whether or not there will be enough buying interest in market-cap weighted indices like the S&P 500 and the Dow Jones Industrials to avoid a similar fate. The SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) does have impressive support at the 185 level. In my estimation, the best shot that the major benchmarks have in avoiding a “bear market headline” is the same injection that occurred during the euro-zone crisis in 2011. Specifically, nearly all of the U.S. indexes and overseas benchmarks fell 20%-40% during that summer. The Dow and the S&P 500 escaped a similar fate with depreciation of “just” 19%-19.9%, due to “well-timed” stimulus promises by the European Central Bank (ECB) and the U.S. Federal Reserve. Already, Fed fund futures have pushed out their anticipation of a second rate hike out to Q3 (July-September) from March. The market does not believe the Fed party line of 4 rate hikes in 2015. In fact, if the Dow and the S&P 500 do fall to significantly lower levels, one might anticipate the central bank of the United States reversing course; perhaps the notion of negative interest rates and/or QE4 might be introduced to the investing public. Historically speaking, however, the wildcard of a Fed reversal may not be enough to calm the nerves of panicky market-based participants. Take a look at this table for the S&P 500’s first five trading days in January. (Note: I won’t even incorporate the horrific second week that investors are dealing with right now.) The worst first five days for the S&P 500 occurred right here in 2016. But that’s not all. In the table, seven of the nine worst starts ultimately offered poor risk-reward results, either with additional losses or sub-par total gains through year-end. “Wait a second, Gary. Those other two years in 1991 and in 1982 show extraordinary price appreciation. Isn’t that reason enough to be optimistic?” Not if you recognize that the price gains that occurred in 1991 came at the conclusion of the 20% losses for the 1990-1991 stock market bear. And not if you realize that the price appreciation that followed in 1982 came at the end of the 27% losses for the 1981-1982 stock market bear. Right now, we’re not coming off of a 20% price collapse of the S&P 500. It follows that to the extent one wants to take the history of market direction into account, one would have to look at 2016’s prospects in an unfavorable light. I spent the better part of 2014 explaining the benefits of a barbell approach for a late-stage bull . We matched large-cap U.S. stock assets like the iShares Core S&P 500 ETF (NYSEARCA: IVV ), the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ) and the iShares S&P 100 ETF (NYSEARCA: OEF ) with longer-term investment grade bonds like the Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ), the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) and the SPDR Nuveen Barclays Municipal Bond ETF (NYSEARCA: TFI ). By May of 2015, I expressed the tactical asset allocation changes that I believed were necessary in an unfavorable risk-reward environment, encouraging investors to lower their overall exposure to risk assets . Trying to exit markets during panicky sell-offs rarely proves beneficial. That said, if you believe that you may have been too assertive with your exposure to riskier holdings, you might wait for an inevitable bounce higher. One can work his/her way to a more defensive stance until the fundamental, technical and economic backdrop improves. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.