"A lot of lies can be told about a stock, but dividends don't lie. In order to increase dividends, a stock must create a history of producing cash. Analysts can lie, earnings can lie, CEOs can lie, but dividends don't lie. A company must increase its actual earnings in order to raise dividends."
Unless you were an investor that was net "short" the market, you are not upset that January has finally come to an end. The first week of trading in February saw the intense selling pressure continue with volatility that can only be described as irrational behavior.
The S&P 500 was down 5% in January. If not for the 2.4% gain on the last trading day of the month this would be the worst monthly return since May 2010.
Besides the big drop, January 2016 will be remembered for wild volatility. Out of the first 18 trading days this year, 12 have moved at least 1% (up or down). This is the most 1% moves since 12 in October 2014.
This year was the worst start to a year for the S&P 500 after 10 trading days ever. Down 8% topped the previous record of down 6.6% from 2009.
So it is no wonder that market participants are shell shocked.
Now we will hear the cliches as to whether "so goes January, so goes the year", will indeed play out in 2016. When looking back in history, this is not a major warning as many believe. Out of the 7 other times the S&P 500 dropped more than 4% after the first 10 days, only once (2008) did the rest of the year drop significantly.
Maybe the bulls can take some solace in the chart below.
Each market pundit has put together his/her ideas as to what is ailing this market. They try to decipher exactly what changed from December 31st to prompt the voracious selling that January demonstrated. I put forth some ideas on that topic last week and stumbled upon this report recently, indicating that this particular worry may not be as critical as it is made out to be.
Empirical Research suggests that investors are worried the Fed's actions has set off a global financial cycle that will lead to credit crises in the places where most of the capital spending and borrowing occurred, Commodity businesses and the Emerging Markets. That surely is on the long list of concerns that troubles investors.
However they concluded that energy sector and EM debt puts the combined balances at around 7% of U.S. GDP. By comparison subprime and commercial mortgages together represented 40% of output in 2007.
Just as I have indicated they also state that relatively little of the borrowing has been through U.S. banks. Rather the debt is in the hands of money managers, mutual funds, institutional bond products and hedge funds where loss recognition is largely immediate.
Their findings suggest the systemic risks from high yield and EM debt are small. The larger vulnerability is that an EM recession hurts global demand and confidence.
The collapse of crude oil prices has shown up in U.S. corporate capital spending data. Profit margins in the commodity sectors are at 60 year lows while those for the remainder of the market remain at highs, and energy stocks are priced much as the financials were in March of 2009.
This situation is what I referred to last week as a black swan. Few if any saw the close to 80% peak to trough decline in crude oil coming. The question so many continue to ask themselves is whether another 2008 is upon us. In my view, while I acknowledge "issues", the evidence continues to show otherwise.
Let's get back to the issue of volatility. ETF's have been identified as one of the culprits that have exacerbated the wild swings that we have seen recently. I think they add to the situation, but from what I have witnessed in the first five weeks of this year, I cannot remember a longer period of irrational behavior than what I am witnessing lately. I am not referring to the weakness in the market, I am referring to the intraday swings that happen within minutes, not hours.
Whatever the reason there are some simple rules that investors should follow to help them avoid what I call "forced irrationality".
Never put yourself in the position of being forced to sell an asset after it's already taken a huge tumble because you didn't set aside enough cash like instruments to get you through some market turbulence.
Most investors are constantly changing their portfolio holdings based on the market's movements, not their own unique situation or goals. In short, avoid making short term decisions with long term capital.
Avoid using leverage, it amplifies moves in both directions for sure. But it really makes things more painful on the downside when you're forced sell to meet margin calls.
I have often said that an investor needs to have a plan. Without a set of rules and guidelines there is little that will guide an investor's actions when the markets go against them.
If you wish to make money over time, you're never going to be able to avoid risk. What you really want to avoid is making a huge mistake with risky assets at the wrong time. The best investors understand how to minimize their own irrationality and take advantage of the irrationality of others. In summary, I follow my first rule of investing, use the "fear and greed" cycles to your advantage.
This past week's ISM Manufacturing report for the month of January came in weaker than expected for the sixth month in the last seven, and the eleventh month in the last fourteen. Needless to say, manufacturing in the U.S. has been in a funk for quite some time. While economists were expecting the headline reading in the ISM report to come in at a level of 48.4, the actual reading was 0.2 weaker at 48.2. That was the same level as last month's initial reading, but the December reading was revised down to 48.0.
The pessimists will cite the fact that the headline number is at levels last seen during the last recession. It has been in contraction for four straight months now, and has consistently missed expectations.
The optimists will key on the fact that today's headline reading increased for the first time since last May and that the internals were positive with both Production and New Orders moving back above 50. The reality sits somewhere in the middle. The report was not good by any means, but at least showed some improvement/stabilization.
From what I was able to gather this week, the consumer appears to be doing fine:
"Personal consumption expenditures were unchanged in December after having risen 0.5% in December. What we are really interested in is consumption spending in real terms (i.e., after adjustment for inflation) because that is what goes into GDP. On that basis consumption spending rose 0.1% in December."
"Personal income rose 0.3% in both November and December. During the past year personal income has risen 4.2%. Real disposable income which is what is left after inflation and taxes has risen 3.1% in the past year.
I found this bit of information quite revealing;
Real disposable income per capita is generally regarded as the best measure of our standard of living. It is currently rising at a 2.3% pace which is quite a bit faster than the 1.6% average increase in the past 25 years."
No one knows for sure, but if oil prices remain at current levels, consumer savings would equate to almost half a point of GDP. Thus far, the data shows consumers have banked a good deal of the savings.
"With income outpacing spending in December, savings surged to $753.3 billion, the highest level since December 2012, from $717.8 billion in November."
The chart below is the most popular and well tracked of several leading indexes. The Conference Board's Index of Leading Indicators (LEI).
LEI has yet to take out its prior high of 2006. Prior round trips are denoted by the dotted lines on the chart above. The subsequent solid lines (and years markers) represent the length of time between the round trip and the next recession. So, a glance at the history of this data suggests the next major bump in the road for the economy is more likely still ahead of us, than upon us.
U.S. manufacturing has been pretty sick over the last few months, but for most of this time the services sector, which is a much larger share of the economy, has been holding up relatively well. The big question facing the economy was whether or not the ills of the manufacturing sector would infect the services sector or remain contained. T
This past week the ISM report on the Non-Manufacturing sector showed that while the services sector is still relatively healthy and nowhere near as sick as the manufacturing sector, it has come down with a cold. While economists were expecting the headline reading to come in at a level of 55.1, the actual reading was quite a bit weaker at 53.5. This is still in expansion territory, but it is the lowest level in nearly two years. Taking this report and the recent report on the Manufacturing sector, the combined ISM fell to 52.9 from 54.4. That's also the lowest level since February 2014.
Total non farm payroll employment rose by 151,000 jobs in January. The initial reaction was negative as many jumped to the conclusion that the weakness in the economy is spilling over to the job market. Before anyone gets too wrapped up in this report, sit back, relax and add the revised November and December jobs to this number. The 3 month average is 231,000. I also noted in the details of this report, the beleaguered manufacturing sector added 29,000 jobs or 19% of the total.
China's Manufacturing PMI reports continue to show the results of the ongoing shift from a manufacturing dominated economy to a consumer based economy.
The report came in 49.4, slightly missing Reuters consensus estimates for a 49.6 reading and ticking down from the 49.7 figure in December.
"Chinese manufacturers signaled a modest deterioration in operating conditions at the start of 2016, with both output and employment declining at slightly faster rates than in December. Total new business meanwhile fell at the weakest rate in seven months."
Helping to offset the disappointment was a separate survey also released this past week that showed growth in the Chinese services sector had held above the key 50 level. The January official non-manufacturing purchasing managers index came in at 53.5, versus 54.4 in December.
EARNINGS and VALUATIONS
Every earnings season I maintain this document highlighting the headlines of corporate earnings. It gives an investor a quick glance on the results reported to date.
From Thomson Reuters:
Forward 4-quarter estimate this week fell to $123.06 vs. $124.53
The P.E ratio as of Friday, January 29, was 15.7(x)
The PEG ratio is still 3(x) on a core basis and 7(x) versus the stated growth rate
The SP 500 earnings yield is still elevated at 6.34% vs last week's 6.53%
The y/y growth rate of the forward estimate was 2.08% as of Friday, January 29th versus last week's 1.67%. This is the first sustained increase in the y/y growth rate since last April, 2015.
"More Companies Beating EPS Estimates, But Fewer Companies Beating Sales Estimates."
With 63% of the companies in the S&P 500 reporting actual results for Q4 to date, more companies are reporting actual EPS above estimates (70%) compared to the 5-year average, while fewer companies are reporting sales above estimates (48%) relative to the 5-year average. In aggregate, companies are reporting earnings that 3.7% above the estimates. This percentage is below the 5-year average (+4.7%).
At the sector level, the Materials (83%), Health Care (81%), and Information Technology (81%) sectors have the highest percentages of companies reporting earnings above estimates, while the Utilities (27%) and Telecom Services (33%) sectors have the lowest percentages of companies reporting earnings above estimates.
Health Care (68%) and Information Technology (66%) sectors have the highest percentages of companies reporting revenues above estimates, while the Materials (17%) and Utilities (27%) sectors have the lowest percentages of companies reporting revenues above estimates.
Birinyi Associates summarizes where the various indexes stand today regarding multiples and yields
An interesting look into the question, "Are stocks overvalued?" From that missive:
"Another measurement that can be employed to evaluate equity valuations is their relationship to bonds. Growth has indeed been weaker than forecast, the rate of return on bonds has also been revised downwards. And what matters for the valuation of stocks is the relation between future growth and future interest rates. Put another way, the equity premium, the difference between the expected rate of return on stocks and the expected rate of return on bonds, has if anything increased relative to where it was before the crisis."
I believe this chart sums up how most investors feel right now.
While the chart below demonstrates how money managers are positioned regarding U. S. equity exposure.
The levels are similar to other market reversals.
Investors continue to be on the defensive if not outright bearish. In the last week of January, $3.8b went into treasury funds, making it the 7th week in a row for inflows. A massive $13.9b went to money market funds in the same period
Similarly, investors in Rydex funds have one of the largest percentage of their assets in bearish equity funds and in money market funds as a percentage of their total assets in the past 10 years.
CRUDE OIL and the USD
This Rhino Trading Partners quote nicely summarizes what many have now found out to be fact;
"If anyone tells you that they feel they know where the bottom will be in oil, back away from this person as quickly as you can.''
Speaking of volatility this past week, WTI was down 6% on Tuesday and up 8% on Wednesday. This is a market that is not moving on any fundamental data that is being presented. It is a market trading on emotion and emotion alone. I suggest the equity market that has for the most part followed these moves is also doing the same.
Despite all of the strong dollar talk by the market pundits, perhaps my thoughts that the upward trend would abate may finally be coming to fruition. The USD appreciated 25% from September 1 to December 1, 2015. Since that time the USD is relatively flat and at the moment down 2% from the December high.
Bulls will look for a consolidation of the 25% rise from June 2014 to present as a sign that the USD may now settle into a trading range. If that does take place, WTI has a chance to stabilize here and perhaps move higher.
THE TECHNICAL PICTURE
Not much if anything has changed on the LT picture. The S&P sits approximately 7% from the all important 20 Month Moving average at 2026. The possibility that the S&P can retake that level grows slimmer by the day.
The chart of the short term view gives an investor a clear picture of the support level that is now in play.
If we roll out the old axiom that "markets never bottom on a Friday", then we could easily see the January lows tested. The more a level is tested the higher the probability that a break will occur.
Given this technical picture, I updated and put forth my evolving portfolio strategy in the Summary/Conclusion portion of this article.
Regardless of how one is interpreting the stock market these days, companies raising their dividends in a challenging environment are a long term investors dream. The opening quote from Mr. Russell highlights the fact that there is little to be argued that companies raising dividends are solid investments.
For those not familiar, the best place to start research in that area is the Dividend Aristocrats that have raised dividends for the last 25 years. Another great source to uncover the solid dividend payers is the Dividend Champion list compiled by David Fish.
The banks received some good press this past week as Barron's was out with a plug for the sector.
For those suggesting that the weakness in the "Financials" is sniffing out the next 2008, I believe they have been thrown a curve ball and got the story wrong. I recently saw a graphic that shows the sovereign wealth funds which have been selling lately have 45% of their funds in financials. That may suggest the financial weakness isn't telling us anything but forced liquidation.
Sentimentrader notes that "seasonality" now favors the energy sector for the next 3 months. It will be very interesting to see it if that holds true in 2016.
Despite the short term negatives that exist with the political grandstanding, (This too shall pass) I continue to believe that the biotech/biopharma industry is the next great growth industry.
One only has to look at the recent earnings results to see where the revenue growth is in this no growth environment.
Gilead reports Q4 adjusted EPS $3.32, consensus $3.00
Reports Q4 revenue $8.51B, consensus $8.13B.
Gilead raises quarterly dividend 10%, announces additional $12B share buyback
Results, combined with shareholder friendly, value conscious behavior of Gilead management is a rarity. I continue to build an overweight position on GILD during any market weakness.
Occidental Petroleum (OXY) reported an "in line" quarter but it was the details from the conference call that caught my attention.
CEO Stephen Chazen:
"In 2015, we continued exiting our non-core assets in order to streamline the business. Our 2015 capital spending was down by 36% compared to a year ago, and total company production still grew by 14% with Permian Resources growing 47%. We continue to focus on capital and operating efficiencies. Our Permian drilling and completion costs declined by 33%. Total company operating costs declined by nearly $2.00 per barrel to $11.57 and fell further in the fourth quarter."
The company continues to be my top pick in the energy space.
During this last market swoon the healthcare REITS have held up well. The sector is a prime candidate to find names that will add some stability and yield to your holdings. OHI, DOC are two that I own and have mentioned before.
If you believe we are on the precipice of another 2008 crisis then read no further. I am now starting to find names with strong cash flow and balance sheets with yields in excess of 3.5% selling at conservative market multiples.
CSCO, PE 12, 3.7% yield
INTC, PE 12, 3.5% yield
MRK, PE 13 3.8% yield
ABBV, PE 17 4.3% yield
RGC, PE 18 5.1% yield
SUMMARY AND CONCLUSION
The stock market as measured by the S&P is now facing what could be a key test. The bulls would rather see events unfold with less emotion than what we have witnessed lately. The stock market rarely gives investors what they want.
Uncertainty has gripped the equity markets. There is a buying malaise that has added to the shadow that has been cast on the entire market. No one wishes to step up amidst the fear and panic that is all around them.
Right or wrong, what will continue to weigh on the stock market will be the direction of the price of crude oil and the trading in the High Yield Junk Bond market. The forced liquidation by the sovereign wealth funds adds selling pressure that has not been seen in quite some time.
After wrestling with that notion for a while now, I do believe it is why we have not seen any wild spikes in the VIX that would accompany a selling climax or a market bottom. The S&P was off 35 Points on Friday and the VIX was 23. Typically one would expect a VIX in the upper 30's or much higher given the magnitude of that decline. As an example the VIX spiked to 52 during the August 2015 sell off.
Instead, it is unrelenting forced selling that continues unabated as the price of crude oil stays at these levels. No one has any idea when that may subside. That selling pressure simply begets more selling, emotions are ramped up, and investors grow nervous by the hour.
Lost in the negativity, were two 90% upside days (Volume on the NYSE was 90% positive) during the last week of January. These types of occurrences are rare and to have two in the same week is impressive and shouldn't be dismissed. Equities have a strong tendency to add to gains in the weeks ahead. The Bulls will need this potential positive in their corner to mount some form of market stabilization.
The data shows that a fair share of investors and money managers made drastic positioning changes in August, again in September 2014 and now in the early part of 2016.
Will they be right? Maybe. The S&P sits right at the same levels where the warnings for the "next leg down" were first heard.
Is it an absolute fact that a market "crash" is yet to come? What if the S&P stays in a trading range? Investors continue to be on the defensive as indicated by the "positioning" data that I laid out earlier. This may also prove to be a "contrarian positive" for the bullish theme as the "test" plays out.
Time will tell, investors will garner more insight as to where the market is headed as events unfold.
Since I do not know if the S&P will in fact hold at these levels and pass the test, I initiated the plan that I laid out a few weeks ago. A covered call strategy to add income and offer minimal protection for a portion of my core positions was put in place this past week.
The next part of my strategy will be to monitor every individual position to see if it breaks below their respective August lows. A decision will be made to either sell the position or buy puts for protection, as I look to get more defensive on those stocks that break below their August low.
The question of how to position a portfolio now resides with the individual and his/her risk tolerance. There really is no right/wrong answer with all of the variables one has to use in their thought process.
Best of Luck to All!
Disclosure: I am/we are long ABBV,CSCO,GILD,BAC,INTC,MRK,OXY,OHI,DOC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.