Energizer Market… Keeps Going and Going

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (May 2, 2016). Subscribe on the right side of the page for the complete text.

Boom, boom, boom…it keeps going…and going…and going…

You’ve seen the commercials: A device operating on inferior batteries dies just as a drum-beating, battery operated Energizer bunny comes speeding and spiraling across the television screen. Onlookers waiting for the battery operated toy to run out of juice, instead gaze in amazement as they watch the energized bunny keep going and going. The same phenomenon is occurring in the stock market, as many observers eagerly await for stock prices to die. The obituary of the stock market has been written many times over the last eight years (see Series of Unfortunate Events). Mark Twain summed up this sentiment well, when after a premature obituary was written about him, he quipped, “The reports of my death are greatly exaggerated.”

With fears abound, stocks added to their annual gains by finishing their third consecutive positive month with the S&P 500 indexes and Dow Jones Industrial Average advancing +0.5% and +0.3%, respectively. Skeptics and worry-warts have been concerned about stocks plummeting ever since the Financial Crisis of 2008-2009. We experienced a 100 year flood then, and as a consequence, scarred investors now expect the 100 year flood to repeat every 100 days (see also 100 Year Flood). Given the damage created in the wake of the “Great Recession,” many individuals have become afraid of their own shadow. The shadows currently scaring investors include the following:

  • Negative Interest Rates: The unknown consequences of negative interest rate policies by central banks (see chart below).
  • U.S. Monetary Policy: The potential continuation of the Federal Reserve hiking interest rates.
  • Sluggish Economic Growth: With a GDP growth figure up only +0.5% during the first quarter many people are worried about the vulnerability of slipping into recession.
  • Brexit Fears: Risk of Britain exiting the European Union (a.k.a. “Brexit”) will blanket the airwaves as the referendum approaches next month

For these reasons, and others, the U.S. central bank is likely to remain accommodative in its stance (i.e., Fed Chairwoman Janet Yellen is expected to be slow in hitting the economic brakes via interest rate hikes).

c bank rates

Source: Financial Times. Central banks continue with attempts to stimulate with zero/negative rates.

Climbing the Wall of Worry

Despite all these concerns, stock prices continue climbing the proverbial “wall of worry” while approaching record levels. As famed investor Sir John Templeton stated on multiple occasions, “Bull markets are born on pessimism, and they grow on skepticism, mature on optimism, and die on euphoria.” It’s obvious to me there currently is no euphoria in the overall market, if you consider investors have withdrawn $2 trillion in stock investments since 2007. The phenomenon of stocks moving higher in the face of bad news is nothing new. A recent study conducted by the Financial Times newspaper shows the current buoyant bull market entering the second longest advancing period since World War II (see chart below).

bull markt cal days

Source: Financial Times

There will never be a shortage of concerns or bad things occurring in a world of 7.4 billion people, but the Energizer bunny U.S. economy has proven resilient. Our economy is entering its seventh consecutive year of expansion, and as I recently pointed out the job market keeps plodding along in the right direction – unemployment claims are at a 43-year low (see Spring Has Sprung). Over the last few years, these job gains have come despite corporate profits being challenged by the headwinds of a stronger U.S. dollar (hurts our country’s exports) and tumbling energy profits. Fortunately, the negative factors of the dollar and oil prices have stabilized lately, and these dynamics are in the process of shifting into tailwinds for company earnings. The -5.7% year-to-date decline in the Dollar Index coupled with the recent rebound in oil prices are proof that the economic laws of supply-demand eventually respond to large currency and commodity swings. With the number of rigs drilling for oil down by approximately -80% over the last two years, it comes as no surprise to me that a drop in oil supply has steadied prices.

The volatility in oil prices has been amazing. Energy companies have been reeling as oil prices dropped -76% from a 2014-high of $108 per barrel to a 2016-low of $26 per barrel. Since then, the picture has improved significantly. Crude oil prices are now hovering around $46 per barrel, up +76%.

Energy Bankruptcy & Recessionary Fears Abate

If you take a look at the borrowing costs of high-yield companies in the chart below (Calafia Beach Pundit), you can see that prior spikes in the red line (all high-yield borrowing costs) were correlated with recessions – represented by the gray periods occurring in 2001 and 2008-09. During 2016, you can see from the soaring blue line, investors were factoring in a recession for high-yield energy companies (until the oil price recovery), but the non-energy companies (red-green lines) were not anticipating a recession for the other sectors of the economy. Bottom-line, this chart is telling you the knee-jerk panic of recessionary fears during the January-February period of this year has quickly abated, which helps explain the sharp rebound in stock prices.

hy crdt yields

After a jittery start to 2016 when economic expectations were for a dying halt, investors have watched stocks recharge their batteries in March and April. There are bound to be more fits and starts in the future, as there always are, but for the time being this Energizer bunny stock market and economy keeps going…and going…and going…

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

May 2, 2016 at 1:11 pm Leave a comment

Michael Jordan and Market Statistics

Basketball Match

Basketball is in the air as the NBA playoffs are once again upon us. While growing up in high school, Michael Jordan was my basketball idol, and he dominated the sport globally at the highest level. I was a huge fanatic. Besides continually admiring my MJ poster-covered walls, I even customized my own limited edition Air Jordan basketball shoes by applying high school colors to them with model paint – I would not recommend this fashion experiment to others.

Eventually the laws of age, physics, and gravity took over, as Jordan slowly deteriorated physically into retirement. On an infinitesimally smaller level, I also experienced a similar effect during my 30s when playing in an old man’s recreational basketball league. Day-by-day, month-by-month, and year-by-year, I too got older and slower (tough to believe that’s possible) as I watched all the 20-somethings run circles around me – not to mention my playing time was slashed dramatically. Needless to say, I too was forced into retirement like Michael Jordan, but nobody retired my number, and I still have not been inducted into the Hall of Fame.

“Air Wade” Before Retirement: No Photoshop in 1988, just an optical illusion created by an 8-foot rim.

“Air Wade” Before Retirement: No Photoshop in 1988, just an optical illusion created by an 8-foot rim.

Financial markets are subject to similar laws of science (economics) too. The stock market and the economy get old and tired just like athletes, as evidenced by the cyclical nature of bear markets and recessions. Statistics are a beautiful thing when it comes to sports. Over the long run, numbers don’t lie about the performance of an athlete, just like statistics over the long run don’t lie about the financial markets. When points per game, shooting percentage, rebounds, assists, minutes played, and other measurements are all consistently moving south, then it’s safe to say fundamentals are weakening.

I’ve stated it many times in the past, and I’ll state it again, these are the most important factors to consider when contemplating the level and direction of the stock market (see also Don’t Be a Fool, Follow the Stool).

  • Profits
  • Interest Rates
  • Valuations
  • Sentiment

While the absolute levels of these indicators are important, the trend or direction of each factor is also very relevant. Let’s review these factors a little more closely.

  • Profits: Profits and cash flows, generally speaking, are the lifeblood behind any investment and currently corporate profits are near record levels. When it comes to the S&P 500, the index is currently expected to generate a 2016 profit of $117.47. Considering a recent price closing of 2,092 on the index, this translates into a price-earnings ratio (P/E) of approximately 17.8x or a 5.6% earnings yield. This earnings yield can be compared to the 1.9% yield earned on the 10-Year Treasury Note, which is even lower than the 2.1% dividend yield on the S&P 500 (a rare historical occurrence). If history repeats itself, the 5.6% earnings yield on stocks should double to more than 10% over the next decade, however the yield on 10-year Treasuries stays flat at 1.9% over the next 10 years. The strong dollar and the implosion of the energy sector has put a lid on corporate profits over the last year, but emerging signs are beginning to show these trends reversing. Stabilizing profits near record levels should be a positive contributor to stocks, all else equal.
  • Interest Rates: Pundits have been pointing to central banks as the sole reason for low/negative interest rates globally (see chart below). NEWS FLASH: Central banks have been increasing and decreasing interest rates for decades, but that hasn’t stopped the nearly unabated 36-year decline in interest rates and inflation (see chart below). As I described in previous articles (see Why 0% Rates?), technology, globalization, and the rise of emerging markets is having a much larger impact on interest rates/inflation than monetary policies. If central banks are so powerful, then why after eight years of loose global monetary policies hasn’t inflation accelerated yet? Regardless, all else equal, these historically low interest rates are horrible for savers, but wonderful for equity investors and borrowers.

    Source: Calafia Beach Pundit

    Source: Calafia Beach Pundit

  • Valuations: The price you pay for an investment is one of the, if not the, most important factors to consider. I touched upon valuations earlier when discussing profits, and based on history, there is plenty of evidence to support the position that valuations are near historic averages. Shiller CAPE bears have been erroneously screaming bloody murder over the last seven years as prices have tripled (see Shiller CAPE smells like BS). A more balanced consideration of valuation takes into account the record low interest rates/inflation (see The Rule of 20).
  • Sentiment: There are an endless number of indicators measuring investor optimism vs. pessimism. Generally, most experienced investors understand these statistics operate as valuable contrarian indicators. In other words, as Warren Buffett says, it is best to “buy fear, and sell greed.” While I like to track anecdotal indicators of sentiment like magazine covers, I am a firm believer that actions speak louder than words. If you consider the post-crisis panic of dollars flowing into low yielding bonds – greater than $1 trillion more than stocks (see Chicken vs. Beef ) you will understand the fear and skepticism remaining in investors minds. The time to flee stocks is when everyone falls in love with them.

Readers of Michael Lewis’s book Moneyball understand the importance statistics can play in winning sports. Michael Jordan may not have been a statistician like Billy Beane, because he spent his professional career setting statistical records, not analyzing them. Unfortunately, my basketball career never led me to the NBA or Hall of Fame, but I still hope to continue winning in the financial markets by objectively following the all-important factors of profits, interest rates, valuations, and sentiment.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

April 23, 2016 at 5:39 pm 2 comments

Want to Retire at Age 90?

sleep sit 90

Do you love working 40-50+ hour weeks? Do you want to be a Wal-Mart (WMT) greeter after you get laid off from your longstanding corporate job?  Do you love relying on underfunded government entitlements that you hope won’t be insolvent 10, 20, or 30 years from now? Are you banking on winning the lottery to fund your retirement? Do you enjoy eating cat food?

If you answered “Yes” to one or all of these questions, then do I have a sure-fire investment program for you that will make your dreams of retiring at age 90 a reality! Just follow these three simple rules:

  • Buy Low Yielding, Long-Term Bonds: There are approximately $7 trillion in negative yielding government bonds outstanding (see chart below), which as you may understand means investors are paying to give someone else money – insanity. Bank of America recently completed a study showing about two-thirds of the $26 trillion government bond market was yielding less than 1%. Not only are investors opening themselves up to interest rate risk and credit risk, if they sell before maturity, but they are also susceptible to the evil forces of inflation, which will destroy the paltry yield. If you don’t like this strategy of investing near 0% securities, getting a match and gasoline to burn your money has about the same effect.

negative bonds apr 16

Source: Financial Times

  • Speculate on the Timing of Future Fed Rate Hikes/Cuts: When the economy is improving, talking heads and so-called pundits try to guess the precise timing of the next rate hike. When the economy is deteriorating, aimless speculation swirls around the timing of interest rate cuts. Unfortunately, the smartest economists, strategists, and media mavens have no consistent predicting abilities. For example, in 1998 Nobel Prize winning economists Robert Merton and Myron Scholes toppled Long Term Capital Management. Similarly, in 1996 Federal Reserve Chairman Alan Greenspan noted the presence of “irrational exuberance” in the stock market when the NASDAQ was trading at 1,350. The tech bubble eventually burst, but not before the NASDAQ tripled to over 5,000. More recently, during 2005-2007, Fed Chairman Ben Bernanke whiffed on the housing bubble – he repeatedly denied the existence of a housing problem until it was too late. These examples, and many others show that if the smartest financial minds in the room (or planet) miserably fail at predicting the direction of financial markets, then you too should not attempt this speculative feat.
  • Trade on Rumors, Headlines & Opinions: Wall Street analysts, proprietary software with squiggly lines, and your hot shot day-trader neighbor (see Thank You Volatility) all promise the Holy Grail of outsized financial returns, but regrettably there is no easy path to consistent, long-term outperformance. The recipe for success requires patience, discipline, and the emotional wherewithal to filter out the endless streams of financial noise. Continually chasing or reacting to opinions, headlines, or guaranteed software trading programs will only earn you taxes, transaction costs, bid-ask spread costs, impact costs, high frequency trading manipulation and underperformance.

Saving for your future is no easy task, but there are plenty of easy ways to destroy your savings. If you want to retire at age 90, just follow my three simple rules.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in WMT or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

April 16, 2016 at 11:00 am 1 comment

Avoiding Cigarette Butts

cigarette-butt-1579806

Too many investors hang their hat on investments that seem “cheap”. Unfortunately, too often something that looks like a bargain turns out to be a cigarette butt from which investors are hoping to take a last puff. As the old adage states, “you get what you pay for,” and that certainly applies to the world of investments. There are endless examples of cheap stocks getting cheaper, or in other words, stocks with low price/earnings ratios going lower. Stocks that appear cheap today, in many cases turn out to be expensive tomorrow because of deteriorating or collapsing profitability.

For instance, take Haliburton Company (HAL), an energy services company. Wall Street analysts are forecasting the Houston, Texas based oil services company to achieve 2016 EPS (earnings per share) of $0.32, down -79%. The share price currently stands at $37, so this translates into an eye-popping valuation of 128x P/E ratio, based on 2016 earnings estimates. What has effectively occurred in the HAL example is earnings have declined faster than the share price, which has caused the P/E to go higher. If you were to look at the energy sector overall, the same phenomenon is occurring with the P/E ratio standing at a whopping 97x (at the end of Q1).

These inflated P/E ratios are obviously not sustainable, so two scenarios are likely to occur:

  • The price of the P/E (numerator) will decline faster than earnings (denominator)
    •                                             AND/OR
  • The earnings of the P/E (denominator) will rise faster than the price (numerator)

Under either scenario, the current nose-bleed P/E ratio should moderate. Energy companies are doing their best to preserve profitability by cutting expenses as fast as possible, but when the product you are selling plummets about -70% in 18 months (from $100 per barrel to $30), producing profits can be challenging.

The Importance of Price (or Lack Thereof)

Similarly to the variables an investor would consider in purchasing an apartment building, “price” is supreme. With that said, “price” is not the only important variable. As famed investor Warren Buffett shrewdly notes, the quality of a company can be even more important than the price paid, especially if you are a long-term investor.

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

 

The advantage of identifying and owning a “wonderful company” is the long-term stream of growing earnings. The trajectory of future earnings growth, more than current price, is the key driver of long-term stock performance.

Growth investor extraordinaire Peter Lynch summed it up well when he stated,

People Concentrate too much on the P, but the E really makes the difference.”

 

Albert Einstein identified the power of “compounding” as the 8th Wonder of the World, which when applied to earnings growth of a stock can create phenomenal outperformance – if held long enough. Warren Buffett emphasized the point here:

“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”

 

Throw Away Cigarette Butts

I have acknowledged the importance of aforementioned price, but your investment portfolio will perform much better, if you throw away the cigarette butts and focus on identifying market leading franchise that can sustain earnings growth. The lower the growth potential, the more important price becomes in the investment question. (see also Magic Quadrant)

Here are the key factors in identifying wining stocks:

  • Market Share Leaders: If you pay peanuts, you usually get monkeys. Paying a premium for the #1 or #2 player in an industry is usually the way to go. Certainly, there is plenty of money to be made by smaller innovative companies that disrupt an industry, so for these exceptions, focus should be placed on share gains – not absolute market share numbers.
  • Proven Management Team: It’s nice to own a great horse (i.e., company), but you need a good jockey as well. There have been plenty of great companies that have been run into the ground by inept managers. Evaluating management’s financial track record along with a history of their strategic decisions will give you an idea what you’re working with. Performance doesn’t happen in a vacuum, so results should be judged relative to the industry and their competitors. There are plenty of incredible managers in the energy sector, even if the falling tide is sinking all ships.
  • Large and/or Growing Markets: Spotting great companies in niche markets may be a fun hobby, but with limited potential for growth, playing in small market sandboxes can be hazardous for your investment health. On the other hand, priority #1, #2, and #3 should be finding market leaders in growth markets or locating disruptive share gainers in large markets. Finding fertile ground on long runways of growth is how investors benefit from the power of compound earnings.
  • Capital Allocation Prowess: Learning the capital allocation skillset can be demanding for executives who climb the corporate ladder from areas like marketing, operations, or engineering. Regrettably, these experiences don’t prepare them for the ultimate responsibility of distributing millions/billions of dollars. In the current low/negative interest rate environment, allocating capital to the highest return areas is more imperative than ever. Cash sitting on the balance sheet earning 0% and losing value to inflation is pure financial destruction. Conservatism is prudent, however, excessive piles of cash and overpaying for acquisitions are big red flags. Managers with a track record of organically investing in their businesses by creating moats for long-term competitive advantage are the leaders we invest in.

Many so-called “value” investors solely use price as a crutch. Anyone can print out a list of cheap stocks based on Price-to-Earnings, Enterprise Value/EBITDA, or Price/Cash Flow, but much of the heavy lifting occurs in determining the future trajectory of earnings and cash flows. Taking that last puff from that cheap, value stock cigarette butt may seem temporarily satisfying, but investing into too many value traps may lead you gasping for air and force you to change your stock analysis habits.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in HAL or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

 

April 9, 2016 at 5:32 pm Leave a comment

Spring Has Sprung: Market Weather Turning

Ox-eye daisies

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 1, 2016). Subscribe on the right side of the page for the complete text.

It was a cold winter for stocks, but as we approached the spring season in March, the flowers have begun to bloom. More specifically, during the month of March, the Dow Jones Industrial index catapulted +7.1% and the S&P 500 index jumped +6.6%. While this roughly +80% annualized rate is unlikely to sustain itself, this flurry of strong performance could be the sign of warmer weather conditions in the economic forecast.

What started out as a cold and blustery January, with stocks posting one of the worst beginning months in history (S&P 500 down -5.1%), quickly thawed out in February and March. Fears over deteriorating economic conditions in the U.S., China along with plummeting oil prices proved fleeting. In fact, as Scott Grannis at Calafia Beach Pundit  pointed out, there is no sign of recession in the U.S. as evidenced by a 43-year low in unemployment claims and a 4.9% unemployment rate (see chart below).

Unemployment Claims 3-16

As I’ve stated for many years, focusing on the never-ending hurricane of pessimistic headlines is a wasteful use of time and destructive force on performance, if acted upon. Offsetting the downpour of negative news stories are the record low interest rates (now incomprehensibly negative in parts of the globe), which serve as a protective umbrella against the short-term stormy volatility. When investors face the soggy reality of earning a near-0% return on their bank savings and a sub-2% Treasury bond market for 10-year maturities, suddenly a 6-7% earnings yield on stocks certainly looks pretty sunny. There have been very few times in history when dividends earned on stocks have exceeded the payments received on a 10 year Treasury bond, but that is exactly the extreme environment we are living in today. No doubt, if the interest rate climate changes, and rates spike higher, stocks will face a more thunderous environment.

However, fortunately for stock market investors (and unfortunately for savers), this week Federal Reserve Chair Janet Yellen reiterated her forceful view of maintaining interest rates at a low, stimulative level for an extended period of time.

If It Bleeds It Leads – At the Expense of Your Portfolio

Even in the face of European terrorist attacks in Brussels and a turbulent (but entertaining) political presidential election season, the four pillars of earnings, interest rates, valuations, and sentiment are still protecting stock investors from an economic flood (see also Don’t Be a Fool, Follow the Stool). Scary news headlines may sell newspapers and attract advertising dollars, but the real money is made by following the four investing pillars.

Also contributing to a clearer outlook this spring is the steadying value of the U.S. dollar and stabilizing trend realized in oil prices.

For most of 2015, multinational corporations saw their profits squeezed due to a 20-25% spike in the dollar. For example, an auto manufacturer selling a car for $20,000 in the U.S. could suddenly see the price of the same car changed to $25,000 in Europe. Meanwhile, a different German competitor could price a similar car manufactured in their country at the lower $20,000. This all translates into diminished sales and profits for American companies. Mercifully, we are beginning to see these currency headwinds abate, and even begin to shift into a slight tailwind (see 5-year chart below).

Source: barchart.com

Source: barchart.com

From copper and corn to silver and soy beans, commodity prices have been in a downward death spiral over the last five years. And crude oil hasn’t escaped the commodity collapse either…until recently. The supply glut, created by factors like the U.S. shale revolution and new added Iranian post-sanction reserves, led to price declines from a 2009 high of $147 per barrel to a 2016 low of $26. With China and U.S. dollar fears abating, oil prices have bounced about +45% from the 2016 lows to about $38 per barrel.

While the weather has been improving on our shores, not everyone appreciates the fact the U.S. has been the “best house in a bad global neighborhood.” As the chart below shows (February 2016), international stock markets have gone into a bear market (down > -20%) since the 2011 and 2014 peaks, while the U.S. has performed about 100% better. Even in the U.S. market, small-midcap stocks (small & midsize companies) fell about -22% from their 2015 peak before recouping much of the losses.

Source: Financial Times

Source: Financial Times

Whether large companies, as measured by the S&P 500 index, which fell about -15% from the peak, suffer a true, technical -20% “bear market” or continue the current seven-year bull market is debatable. Regardless, what we do know is investors survived another cold winter and spring has produced a weather forecast that is currently predicting warmer weather and sunnier economic skies.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

April 3, 2016 at 11:59 pm Leave a comment

Chasing Headlines

Chasing FreeImages

It’s been an amazing start to the year. First the market cratered on slowing China economic concerns, domestic recessionary fears, deteriorating oil prices, and negative interest rates abroad. In response to all these worries (and others), stocks dove more than -11% (S&P 500 Index) in January, before settling down. Subsequently, the market has made a screaming recovery, in part due to dovish monetary policy comments (i.e., reduction in forecasted interest rate hikes) and diminished anxiety over a potential global collapse. Month-to-date stocks are up an impressive +5.4%, and year-to-date equities are flattish, or down less than -1%.

With an endless amount of information flowing across our smart phones and computers, it becomes quite easy and tempting to chase news headlines, just like a hyper dog chasing a car. But even once an investor catches up (or reacts) to a headline, there’s confusion around how to profit from the fleeting information. First of all, every plugged-in hedge fund and institutional investor has likely already traded on the stale information you received. Second of all, rarely is the data relevant to the long-term cash generating capabilities of the company or economy. And lastly, the news is more often than not, instantly factored into the stock price. Chasing news headlines only eaves individual investors holding the bag of performance-shattering transactions costs, taxes, and worn-out pricing.

The heightened volatility in late 2015 and early 2016 hasn’t however prevented investors and so-called pundits from attempting to time the market. Any battle-tested investment veteran knows it’s virtually impossible to consistently time the market (see also Market Timing Treadmill), but this fact hasn’t prevented speculators from attempting the feat nonetheless. Famed investment guru, Peter Lynch, who earned an average +29% annual return from 1977-1990, summed it up well when he stated the following:

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

 

The Important Factors

As I’ve written many times in the past, the keys to long-term stock performance are not knee-jerk reactions to headlines, but rather these following crucial factors (see also Don’t Be a Fool, Follow the Stool):

  • Profits
  • Interest Rates
  • Sentiment
  • Valuations

On the profit growth front, corporate income has been pressured by numerous headwinds over the last few years, including an export-shattering increase in the value of the U.S. dollar and a profit-squeezing collapse in energy sector earnings. As you can see from the chart below, the value of the U.S. dollar increased by about 25% from mid-2014 to early-2015, in part because of diverging global central bank policies (more hawkish U.S. Fed vs. more dovish ECB/international central banks). Since that spike, the dollar has settled into a broad range (95 – 100), and the former forceful headwind have now turned into modest tailwinds. This trend is important because an estimated 35-40% of corporate profits are derived from international operations.

Adding insult to injury, the roughly greater than -70% decline in forward energy earnings over the last 18 months has caused a significant hit to overall S&P 500 profits. The tide appears to be finally turning (or at least stabilizing) however, as we’ve seen oil prices rebound by about +30% this year from the lows in January. If these aforementioned trends persist, profit pressures in 2016 are likely to abate significantly, and may actually become additive to growth.

U.S. Dollar 3-26-16

Source: Barchart.com

Profits are important, but so are interest rates. While incessant talk about the path of future Fed policy continues to blanket the airwaves (see also Fed Fatigue), absent a rapid increase in interest rates (say 300-400 basis points), interest rates remain unambiguously positive for equity markets, providing a floor for the oft-repeated volatility in financial markets. As long as stocks are providing higher yields than many bonds, and depositors are earning 0% (or negative rates) on their checking accounts, stocks may remain unloved, but not forgotten.

And speaking of unloved, the sentiment for stocks remains sour. One need look no further than the quarter-billion dollars in hemorrhaging outflows out of U.S. equity funds (see ICI Long-Term Mutual Fund Flows) since 2014. This deep underlying skepticism serves as a positive contrarian indicator for future equity prices. Right now, very few individual investors are swimming in the pool – the time to get out of the stock market pool is when everyone is jumping in.

And lastly, valuations remain very much in line with historical averages (approximatqely 17x 2016 projected earnings), especially considering the generational low in interest rates. Bears continue to point to the elevated CAPE ratio, which has been a disastrous indicator the last seven years (and longer), as a reason to remain cautious. The ironic part is that valuations are virtually guaranteed to improve a few years from now as we roll off the artificially depressed years of 2008-2010.

When you add it all up, zero (or negative) interest rates, combined with the other key factors of profits, sentiment, and valuations, equities remain an important and attractive part of a diversified long-term portfolio. Your objectives, time horizon, and risk tolerance will always drive the proportion of your equity allocation. Nevertheless, some bond exposure is essential to smooth out volatility. Regardless of your investment strategy, chasing headlines, like a dog chasing a car, serves no purpose other than leaving you with a tired, unproductive investment portfolio.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

March 26, 2016 at 12:29 pm Leave a comment

Cutting Losses with Fisher’s 3 Golden Sell Rules

Returning readers to Investing Caffeine understand this is a location to cover a wide assortment of investing topics, ranging from electric cars and professional poker to taxes and globalization.  Investing Caffeine is also a location that profiles great investors and their associated investment lessons.

Today we are going to revisit investing giant Phil Fisher, but rather than rehashing his accomplishments and overall philosophy, we will dig deeper into his selling discipline. For most investors, selling securities is much more difficult than buying them. The average investor often lacks emotional self-control and is unable to be honest with himself. Since most investors hate being wrong, their egos prevent taking losses on positions, even if it is the proper, rational decision. Often the end result is an inability to sell deteriorating stocks until capitulating near price bottoms.

Selling may be more difficult for most, but Fisher actually has a simpler and crisper number of sell rules as compared to his buy rules (3 vs. 15). Here are Fisher’s three sell rules:

1)      Wrong Facts: There are times after a security is purchased that the investor realizes the facts do not support the supposed rosy reasons of the original purchase. If the purchase thesis was initially built on a shaky foundation, then the shares should be sold.

2)      Changing Facts: The facts of the original purchase may have been deemed correct, but facts can change negatively over the passage of time.  Management deterioration and/or the exhaustion of growth opportunities are a few reasons why a security should be sold according to Fisher.

3)      Scarcity of Cash: If there is a shortage of cash available, and if a unique opportunity presents itself, then Fisher advises the sale of other securities to fund the purchase.

Reasons Not to Sell

Prognostications or gut feelings about a potential market decline are not reasons to sell in Fisher’s eyes. Selling out of fear generally is a poor and costly idea. Fisher explains:

“When a bear market has come, I have not seen one time in ten when the investor actually got back into the same shares before they had gone up above his selling price.”

In Fisher’s mind, another reason not to sell stocks is solely based on valuation. Longer-term earnings power and comparable company ratios should be considered before spontaneous sales. What appears expensive today may look cheap tomorrow.

There are many reasons to buy and sell a stock, but like most good long –term investors, Fisher has managed to explain his three-point sale plan in simplistic terms the masses can understand. If you are committed to cutting investment losses, I advise you to follow investment legend Phil Fisher – cutting losses will actually help prevent your portfolio from splitting apart.

investment-questions-border

 

www.Sidoxia.com

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

March 19, 2016 at 12:00 pm Leave a comment

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