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Cabeza Howe
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Cabeza Howe holds two M.S. degrees in engineering. He has extensive career background in science, engineering and software development. He is a self-made financial analyst and manages his own investment as a business. Focused value investing is his passion. He coined the term... More
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  • UPRO And Leveraged ETFs Are Built For Active Management

    Macro Investor deserves credit in pointing out that leveraged ETF UPRO would have performed very well over that last six decades. But I just want to point out that leveraged ETFs, in particular UPRO, is built to be actively managed. It makes little sense to buy and hold.

    My argument can be seen in my comment on his article, repeated below.

    Your argument indeed holds for the past six decades or so. But nobody should take away complacently that S&P 500 is not volatile and as such one can buy and hold UPRO with great peace.

    (1) S&P 500: 1527 on Mach 24, 2000, and 1531 on Feb. 19, 2013. So it finally got back to its original value after almost 13 years. If you have bought and held the imaginary UPRO, however, you would have lost 83% of your investment after the nearly 13 years!

    (2) This is the far-worse part. S&P 500: 1565 on Oct. 9, 2007, and 677 on Mar. 9, 2009. This is the recent financial crisis. S&P lost 57% of value in only 17 months. However, UPRO would have lost 96% of its value. You basically got wiped out during the 17 months period.

    So, regardless of how the world evolves over the long term you would still be much better off actively managing your UPRO position than just buying and holding it. You certainly should get out when market looks frothy; so you can get back in when it is attractively-valued and fear is running rampant.

    Furthermore, as a prudent investor one should be prepared for the possibility that the world has changed a lot due to a multitude of factors. So, the next six decades might turn out to be rather more volatile than the past six. In that case, you might be wiped out holding UPRO or any other leveraged ETF for the long run.

    Feb 23 9:46 PM | Link | 2 Comments
  • Reality Check: Is Market Detached From Its Fundamentals?

    This is a slightly revised version of my article (with the same title) published by Seeking Alpha on October 23, 2012.

    From March 6, 2009's intraday low to September 14, 2012's intraday high, the S&P 500 has returned an incredible 121%. Yet many traders and investors have missed much of the amazing rally. There are a lot of reasons why this has happened. But I think the most important factors are (1) the ongoing Eurozone crisis and political dramas around the world that constantly drive the risk-on and risk-off cycles, (2) vivid memory of the last financial crisis and rampant fear that continued to freak investors out, and (3) widespread valuation concerns that the market was sugar high and detached from fundamentals.

    Here I'm looking into the valuation issue and trying to specifically answer the question: has the market performance detached from the underlying fundamentals? I will first examine the correlation of the S&P 500 index with a few key economic indicators. Then I will follow it with a historical look of the S&P 500's EPS and P/E ratio. At the end, I will reach a conclusion.

    Market Correlation With Real Retail Sales

    The following figure from FRED (Federal Reserve Economic Data) shows how closely the S&P 500 index has correlated with real retail sales (including food services) since 2007. (Click to enlarge the figure)

    Below is the same correlation since 1992. You can see that over the long term (last twenty years) S&P 500 index does seem to track real retail sales. Since 1992 the only period of significant deviation was the late nineties when the high tech boom drove the market to bubble proportion. As for the current bull market, there's simply no similar detachment of market valuation well above the real retail sales growth trend. (Click to enlarge the figure)

    Market Correlation With Real Personal Income

    The following figure shows how S&P 500 has correlated with real personal income since 2007. (Click to enlarge the figure)

    Below is the same correlation since 1990. Again there is no evidence the market currently has moved well beyond its longer-term (22 years) correlation trend with real personal income. (Click to enlarge the figure)

    Market Correlation With Employment

    The following figure shows the correlation of the S&P 500 index with total nonfarm payroll employment since 1990. The S&P 500 index did grow faster than the nonfarm payrolls lately. But as you will see below, it tracks better with the decrease rate of initial jobless claims. (Click to enlarge the figure)

    The following is the S&P 500 index plotted against the (negative of) 4-week moving average of initial claims since 2007. You must have seen similar graphs somewhere, since Business Insider has published this correlation in the past. Joe Weisenthal has used this correlation to prove that "the market is based on economic fundamentals." Well said. (Click to enlarge the figure)

    But I do want to caution you ahead that, even if the economy continues to improve, one day the initial claims will stop decreasing (say at 300K) thus making it appear that the stock prices are beginning to detach from the initial claims.

    Market Correlation With Industrial Production

    The following shows the correlation between the S&P 500 index and industrial production since 1990. (Click to enlarge the figure)

    Market Correlation With ISM Non-manufacturing Composite Index

    According to Bloomberg, non-manufacturing makes up almost 90% of the U.S. economy. So it is important to see how the S&P 500 index correlates with ISM non-manufacturing composite index (NMFCI). The following shows such a correlation since 2008 (the entire period the NMFCI data are available from the FRED database). Again the correlation looks quite good overall. (Click to enlarge the figure)

    To sum it up, we have examined the correlation of the S&P 500 index with several key economic indicators, including real retail sales, real personal income, nonfarm payroll, initial jobless claims, industrial production, and the ISM non-manufacturing composite index. As a whole, the S&P 500 index has not shown significant detachment from its historical trend-correlation.

    S&P 500 Correlation With Earnings Per Share

    I know what you are saying now. The economic indicators impact corporate America's earnings power. But only earnings are the real fundamentals and drivers for the S&P 500 index. Bingo. You have just hit the core of the issue. I'm going to finally address it in this section.

    (All the plots in this section were based on data published by S&P.)

    The following chart plots the S&P 500 index (quarterly closing price, green line with scale on the right) alongside reported quarterly operating earnings per share (blue line, scale on left) from Q1 1988 through Q2 of 2012. On the left of the plot, it appears that the S&P 500 index was playing a catch up of the robust operating EPS that lasted until 1997. On the right, since the start of 2010, the S&P 500 appeared to be actually lagging the EPS growth. If there is any detachment to the fundamentals, it appears to be a discount or distrust among the market players obviously due to the jittery about European crisis, dysfunctional Washington politics, and lately the weakening emerging and global economy. (Click to enlarge the figure)

    A more intuitive way to view this correlation is of course by simply charting the P/E ratio over the years. Below is a plot of the P/E (E being the operating EPS) ttm from Q4 1988 through Q2 2012. As you can see, contrary to the belief that the current market is frothy, the S&P 500 was trading at almost the lowest valuation in the 24 or so years. During this long span of history, before Q3 2011 there were only four quarters that had a P/E as low as or lower than Q2 2012. They were Q3 1990 and Q4 1988 through Q2 1989. (Click to enlarge the figure)

    I understand that some of you prefer the reported EPS instead of the operating EPS. I can tell you that, other than the absolute value, the result is pretty much the same. The following plots the S&P 500 P/E ttm from Q4 1988 through Q2 2012. Again, it is obvious that the S&P 500 P/E values since 2010 were among the lowest in the past 24 years. (Click to enlarge the figure)

    I have to caution that P/E ratio can be a misleading valudation indicator at the inflection point of a business cycle. One good example would be the huge spike in the figure above around the market bottom of 2009 where the P/E ratio was sky high but later turned out to be the best time to buy stocks. But my point here is that the super-low P/E ratio has been there since early 2010 and has remained so for more than two years without an economic or earnings recession.

    With the latest earnings weakness and ongoing fear of a fiscal cliff next year, it remains to be seen if we are now at that dreadful inflection point. But we have also seen incremental improvement in economic data in the past couple of months and game-changing resolve on ECB's part to stem the Eurozone crisis. On top of that, we have also seen some green shoots for Chinese soft landing. So, the jury is still out if we are really going to be entering a new earnings recession.


    By examining the performance of the S&P 500 index versus various key economic indicators and its real fundamentals, the P/E, for the past two decades or more, there is no evidence that the market is frothy or detached from fundamentals, like many strategists have constantly claimed. On the contrary, compared to its historical P/E ratio over the past 24 years (which is almost a quarter century), it appears that the S&P 500 is undervalued or the most attractive during this whole period. Whether the current low P/E really represents a great bargain now depends entirely on if we will next be entering a lasting period of earnings recession. The stock market can tank from here for a lot of reasons, but frothy fundamentals are certainly not one of them. As a trader, you can sell or short the market during various periods, but don't get caught up doing that for the wrong reason.

    Tags: SPY
    Oct 27 12:46 PM | Link | Comment!
  • 11 Charts That Reveal Apple's Retail Store Trend

    Since last month's iPhone 5 release, a lot of skepticism and pessimism have fallen on Apple (NASDAQ:AAPL). The skepticism and pessimism have not spared Apple's iconic, strategic and yet smallest business segment: its retail store operation. To address some of the concerns, I have pored over Apple's regulatory filings since fiscal year (FY) 2001, when Apple opened its first retail store, and compiled 11 charts that I hope should reveal the trend in this business segment.

    Retail Store Openings

    Chart 1 indicates the number of retail stores Apple has opened (cumulatively) as of the end of each fiscal year since FY 2001. The final FY 2012 store number will remain unavailable until later this month when Apple releases its Q4 and FY12 earnings. So, the number for FY 2012 in the chart is an estimate based on the company's store target released in its previous filings.

    (Chart 1)

    As you can see, Apple is still expanding its retail footprint steadily. But it has slowed down its pace in the U.S. while maintaining rapid international expansion. That makes a lot of sense if you think about it. In mainland China, for example, with a population of 1.3 billion Apple has just opened its fifth retail store last month. And customers started to queue for the store opening at 10 p.m. the previous night!

    Retail Sales and Operating Income Per Square Foot

    These are shown in Chart 2 below. For each fiscal year, I have used average square footage to calculate the net retail store sales (revenue) and operating income per square foot. For FY12 the per-square-foot data were for the past four quarters (NYSE:TTM) ending 3Q12. As you can see, net sales per square foot almost reached the $6,000 mark for the past twelve months (ending 3Q12) at $5,936. Net operating income per square foot came in at $1,510. Net sales will likely break the $6,000 per square foot mark for FY12 and continue to climb in the next quarter (1Q13).

    (Chart 2)

    Retail Operating Margin

    Chart 3 shows the retail operating margin for the past twelve years. Again since FY12 is incomplete, so I have used past four quarters (ending 3Q12) in its place. Retail operating margin remained negative until FY04. Thereafter, it has generally kept improving.

    (Chart 3)

    Chart 4 below is the same as Chart 3 except it started with FY03 to make recent trend easier to be discerned. Retail operating margin hit an intermediate peak at FY09. But it improved again in the past four quarters, which registered an all-time high of 25.4%. For the first nine months of FY12, the retail operating margin fared even better, reaching 26.5% (not shown).

    (Chart 4)

    However, retail operating margin for 3Q12 (not shown) came in at only 21.3% mostly because consumers worldwide postponed iPhone purchases in anticipation of the new iPhone 5 model released last month. You can count on the retail operating margin to improve in 4Q12, but particularly in 1Q13 ending this December.

    Retail Revenue and Operating Income Compared to Total

    Chart 5 compares net retail revenue to total net revenue for the past twelve years. As you can see, even though net retail revenue has increased over the years, Apple's total net revenue has grown at an even faster pace. Again, I have used the past four quarters' data (ending 3Q12) in place of FY12.

    (Chart 5)

    The same can be said for retail operating income, shown in Chart 6.

    (Chart 6)

    Chart 7 plots net retail revenue as a percentage of total net revenue, and retail operating income as a percentage of total operating income. It can be seen that, in the first few years, retail stores contributed an increasing percentage to total revenue and operating income. However, as Apple's total revenue and operating income grew at a faster pace than retail revenue and operating income, respectively, the latter's percentage has been in constant decline in more recent years.

    (Chart 7)

    The comparison above might have proved the success of Apple's retail strategy. Retail stores are not just points of sales. Through superior customer service, education, and image/brand building, they are helping drive the company's overall sales in other channels which grow even faster than the direct sales in retail stores.

    Retail Store Capital Expenditures

    Chart 8 plots Apple's CapEx in retail stores, total CapEx, and operating cash flow for the past twelve years. Note that for FY12, the data are for the first nine months only.

    As can be clearly seen, Apple's operating cash flow has been growing at a faster pace than its retail CapEx for the past few years. Therefore, Apple's current retail CapEx looks like a drop in a bucket when compared to its monstrous operating cash flow. OK, it is not quite a "drop in a bucket." But the current retail CapEx is surely a pocket change compared to the operating cash flow.

    (Chart 8)

    Chart 9 plots retail store CapEx as a percentage of the operating cash flow, and the same as a percentage of the total CapEx. It should be clear that the retail store CapEx has been on a constant decline as a percentage of both the total CapEx and the operating cash flow. For the first nine months of FY12, retail CapEx represented only 1.2% of operating cash flow. Do you see my "pocket change" analogy now?

    (Chart 9)

    When you plot the cumulative retail store CapEx since inception (2001) versus the cumulative operating cash flow in the same period, you get Chart 10. As of June 2012 (end of Q3), Apple has invested a total of $3.3B in retail stores. Note that this represents only 7.9% of the most recent three quarters of operating cash flow. And it is only 2.6% of the cumulative operating cash flow so far since 2001.

    (Chart 10)

    Chart 11 plots the cumulative retail CapEx as a percentage of the cumulative operating cash flow since 2001. Again note the declining trend.

    (Chart 11)

    The retail store CapEx charts above along with the huge international potential mentioned previously should serve to quell concern among some investors that Apple has over-expanded its retail store operation.


    Since 2001, Apple has opened nearly 400 iconic retail stores both in the U.S. and internationally. Both sales and operating profit have grown in these retail stores over the years. However, these retail stores have also helped driven the company's overall sales (that are growing even faster) through superior customer service, education, and brand building. There is a lot of room for the retail operation to grow particularly internationally. And with its monstrous capability in generating operating cash flows, Apple can now expand its retail store operation with comparatively minimal capital expenditures.

    Disclosure: I am long AAPL.

    Oct 08 8:38 PM | Link | 2 Comments
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