Tag Archives: ideas

1704 On The S&P 500 In 2016? Less Far-Fetched Than Investors Want To Believe

How does a favorable bullish uptrend become an unfavorable bearish downtrend? Does the transition happen overnight? Do commentators, analysts, money managers and market participants simultaneously concur that the environment for risk-taking is exceptionally poor? The transition from “good times” to “bad times” is far more gradual than many realize. Granted, prices on the Dow or the S&P 500 may fall apart in a matter of days, changing the narrative from “no reason to worry” to “don’t panic.” That said, there are a wide variety of indications that forewarn mindful investors six to twelve months in advance , including consecutive quarters of corporate profitability declines, economic deceleration, and waning participation in price gains across the majority of assets and asset types. 1. Corporate Profits Have Been Breaking Down For Quite Some Time . Peak profitability for the S&P 500 occurred with the third quarter results of 2014 (9/30). Operating earnings that exclude “non-recurring” charges like one-time losses and loan write-downs came in $114.5; reported, or actual earnings, came in near $106. Not only will operating earnings decline for two consecutive quarters on a year-over-year basis for 12/31/2015, but reported earnings will decline for three consecutive quarters on a year-over-year basis (i.e. Q2, Q3 and Q4 in 2015). An earnings recession – two consecutive quarters of year-over-year declines is a bad omen regardless of the earnings type that one looks at. According to one researcher, Keith McCullough, two consecutive quarters of declining profits always result in bearish price depreciation for the S&P 500 in the subsequent year. Similarly, I have pointed out in past articles that a relationship between a manufacturing recession via erosion of the Institute for Supply Management’s PMI strongly correlates with declining earnings per share (EPS). In other words, as much as cheerleaders look to play up ex-energy (EPS) or the 65%-70% service-oriented (ex-manufacturing, ex industrials, ex transports) economy, overall S&P 500 profitability weakness goes hand-in-hand with overall economic weakness. The last two bear markets tell the tale. Back in 2000, bulls continued to push the idea that consumers were resilient and forward earnings projections (ex tech) looked phenomenal. They missed the bearish turn of events entirely. Back in 2008, bulls opined that forward earnings estimates (ex financials) were attractive, and that manufacturer health was irrelevant. They missed the housing bubble as well as its subsequent bursting. Here in 2016, bulls are confident that the U.S. can shake off $30 oil, energy company stock/bond woes, a manufacturing recession and a sharp global economic slowdown without a 20% drop for the Dow or S&P 500. Unfortunately, there’s more to the story. 2. The U.S. Economy Continues To Slow And The Global Economy Is Getting Worse . In 2014, I talked about the best way to participate in a late-stage bull market. In June of 2015, I advocated lowering one’s overall allocation to riskier assets . Bearish? Cautious would be a more appropriate description for downshifting from 70% equity exposure to 50% equity exposure. One of the key reasons for reducing risk had been the consistency of the downtrend in the global manufacturing. Here is a chart of JP Morgan’s Global Manufacturing PMI that I described in numerous pieces in the summer of 2015. It should not come as a surprise that U.S. corporate earnings peaked near the top of the PMI Index level in September of 2014. Since that time, a super-strong dollar strangled profits as well as U.S. exports. Meanwhile, Fed “de facto” tightening via tapering asset purchases throughout 2014 coupled with its direction shift in overnight lending rates in late 2015 have strained gross domestic product (GDP) growth. Even worse, Russia and Brazil are fighting off nasty recessions. Japan is there as well. China’s slowdown may be accelerating. Oil producing nations are close to falling apart on $30 oil. And expectations for Europe continue to sink, as debts pile up and international trade diminishes. Indeed, it’s not difficult to spot the pattern on global nominal year-over-year GDP. When it’s negative, market-based asset prices, including those in the U.S., are more likely to deteriorate. What about the constant drumbeat that sensational U.S. job growth proves that the domestic economy is healthy? Not only are the majority of new jobs low-paying, part-time positions, but the erosion of 25-54 year-old workers from the labor force – from 83.5% in 2008 to 81% in 2016 – represents millions of non-retirees who are not being counted. What about the notion that the U.S. consumer is resilient? According to a wide range of resources, including data at Federal Reserve web sites, personal consumption expenditures (PCE) is the primary measure of consumer spending on goods and services in the U.S. economy. Some would say that PCE accounts for nearly two-thirds of domestic spending, which would make it a significant driver of economic growth. Here’s the problem. Year-over-year percent growth in PCE has been declining steadily since May-June on 2014, which is roughly in line with more significant reductions in the Federal Reserve’s asset buying program (QE3). 3. Weakness in Breadth Of U.S. Stock Market As Well As Majority Of Asset Types . By May of 2015, when the S&P 500 hit its all-time record (2130), investors had learned that reported profits had declined on a year-over-year basis – 3/31/2015 ($99.25) versus 3/31/2014 ($100.85). In the same vein, by May of 2015, investors were privy to significant deceleration in Global PMI, U.S. manufacturer woes as well as dissipating personal consumer expenditures (PCE). Yet there was more. The NYSE Advance/Decline (A/D) Line seemed to have peaked in late April. From late April through the August-September correction, the number of declining stocks outpaced the number of advancing stocks. In fact, in late July, market breadth had grown so weak, the A/D Line fell below its 200-day moving average for the first time since the euro-zone crisis – four years earlier. What’s more, less than 50% of S&P 500 stocks could claim bullish uptrends. Equally disturbing, the Industrial Select Sector SPDR ETF (NYSEARCA: XLI ), the iShares Transportation Average ETF (NYSEARCA: IYT ) as well as small caps via the iShares Russell 2000 ETF (NYSEARCA: IWM ) had already entered corrections; all had dropped below respective long-term trendlines. In other words, market breadth was extraordinarily weak. Obviously, a great many folks believed that an October snap-back rally had terminated the volatile 12% correction that occurred in the summertime. Not only did the S&P 500 fail to recover the highs from May of 2015, but virtually all asset types never made it back. And now, most of those assets are actually lower than they were at the August/September lows . Take a look at the widespread carnage that extends far beyond the S&P 500 or the Dow. U.S. small caps in the Russell 2000 (IWM) reside near 52-week lows. The same holds true for commodities via the PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ), Europe via the Vanguard FTSE Europe ETF (NYSEARCA: VGK ) and emerging markets via the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ). Still choose to believe that rapid deterioration across asset types as well as within U.S. stocks themselves is irrelevant? Perhaps some data from the wildly popular Bespoke Research team might provide additional perspective. Internally, the average stock in every U.S. stock classification has already fallen more than 20% from a 52-week high (through 1/11/2016), meaning the average stock is in a bear market. Think this is a mathematical slight of hand because of energy stock depreciation? Wrong again. Every stock sector with the exception of consumer stables and utilities – safer haven assets less tied to economic cycles – is down more than the 20% bear market demarcation line. Is it possible for Amazon (NASDAQ: AMZN ), Alphabet (NASDAQ: GOOG ), Facebook (NASDAQ: FB ), Microsoft (NASDAQ: MSFT ), Home Depot (NYSE: HD ) and a host of influential companies to keep market-cap weighted S&P 500 ETFs like the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) from sinking 20%? It’s possible. Is it likely? Not unless the Fed has a change of heart on the direction of its monetary policy and not without unanticipated improvements in both corporate profits and the global economic backdrop. 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.

3 Dividend ETFs to Buy Today

By Aaron Levitt, InvestorPlace Contributor In light of the Federal Reserve’s recent interest rate increase, dividend stocks have continued to take it on the chin. The prevailing idea is that investors will be able to find “safer” high-yielding alternatives than in shares of firms that pay dividends. However,

Most Factor Anomalies Are Not Persistent

Smart-beta indices are constructed to exploit “anomalies” that reward exposure to risk factors beyond what would be expected as “necessary compensation” under the Capital Asset Pricing Model (“CAPM”). Of course, any factor that results in nominal outperformance must be considered on a risk-adjusted basis, since taking on higher risk should engender a greater reward – and investment researchers at S&P Dow Jones Indices think at least some factor “anomalies” aren’t anomalies at all, but just rewards for greater-than-understood risk-taking. Even still, among the remaining anomalies, the researchers think many are “disappearing,” “statistical,” or “attenuated” – and only a few are truly “persistent.” Writing on behalf of S&P Dow Jones, academic Hamish Preston and S&P Dow Jones Index Investment Strategy professionals Tim Edwards and Craig Lazzara express these views in an October 2015 research paper titled ” The Persistence of Smart Beta .” Disappearing Anomalies Disappearing anomalies don’t last. A great example shared by the paper’s authors is the so-called “Weekend Effect” that was popularized by Frank Cross in 1973. Mr. Cross discovered that if investors had bought stocks at their closing prices each Monday and sold them at their closing prices each Friday – avoiding the weekend and the Monday trading session – they would have dramatically outperformed a “buy and hold” strategy from 1950 to the time of his research. But then, almost immediately after the Weekend Effect became well known, the anomaly didn’t just disappear, it reversed. The Weekend Effect rebounded in 1984, only after another academic research paper called it into question – and then, when a paper called “The Reverse Weekend Effect” was published in 2000, the old Weekend Effect returned. As soon as investors gained knowledge of the Weekend Effect, it reversed. When knowledge of the reversal became widespread, the reversal reversed. Now, it’s taken as a given that the Weekend Effect was a coincidence – hence, it was a disappearing anomaly. Statistical Anomalies Perhaps a better approach is for investors to keep knowledge of anomalies they discover secret – that way, they may be less likely to disappear. This is what David Dolos did when he discovered that applying the price movements of the 1720 South Sea Bubble – second only to Tulip Mania in episodes of old-school irrational exuberance – to the Dow Jones Industrial Average inexplicably produced outsized returns. Mr. Dolos never told anyone about his discovery, and he reaped the rewards in anonymity until 2007, when the system broke down. Why? Well first off, David Dolos didn’t exist. The story is made up, and although the 1720 South Sea Bubble was real, the South Sea Bubble effect was data-mined into existence. As the paper’s authors note, modern computing power can easily produce “false positives” – i.e., anomalies that are purely statistical in nature. In order for an anomaly to be persistent, it must make logical sense. Attenuated Anomalies Momentum is one of the most popular factors. Academic research supports its outperformance, and the concept of momentum stocks – stocks that are going up – outperforming non-momentum stocks makes logical sense. The momentum anomaly is known to anyone who cares to know about it, and yet this knowledge hasn’t caused the anomaly to disappear – instead, it has reinforced it. The downside is that since investors have become aware of the momentum anomaly, its drawdowns have been bigger. This is what the S&P Dow Jones authors mean by an “attenuated anomaly.” In 1997, Mark Carhart published a study that showed adding momentum to the famous Fama-French three-factor model boosted returns. This caused more money to flow into momentum stocks, ultimately leading to bigger drawdowns during crashes. Persistent Anomalies Are there any truly persistent anomalies? The authors say there is at least one: Low volatility. But they conclude with a word of caution: “So far, the investment and attention directed toward low-volatility strategies has not been sufficient to temper their returns or attenuate their risk/return profile.” So far. As the well-known disclaimer goes: ” Past performance does not necessarily predict future results. ” For more information, download a pdf copy of the white paper. Jason Seagraves contributed to this article.