Archive for the ‘Stocks - U.S.’ Category

New Highs: What Do They Mean?

Tuesday, July 22nd, 2014

Homes Sales Help Spark Rally

The S&P 500 posted a new intraday high Tuesday after encouraging housing data was released. From Reuters:

U.S. home resales hit an eight month-high in June, suggesting the housing market was gradually regaining momentum and would help the economy to stay on a higher growth path this year. The third straight month of home sales gains, reported by the National Association of Realtors on Tuesday, added to employment and retail sales data that have indicated economic growth ended the second quarter on a firmer note.

S&P Has Not Done This Yet

While the headlines referenced new highs, the S&P 500 needs to close over 1985 and change to make a new closing high. Tuesday’s close fell just short with the final print for the day coming in at 1983.

As noted on Twitter, investors can gain some short-term insight based on where stocks head next.

Earnings Playing A Big Role

Earnings have been pleasing to stock market bulls thus far. However, less than half of the companies in the S&P 500 have pulled back their quarterly curtain. From The Wall Street Journal:

Eighty three of the 116 companies in the S&P 500 that have reported earnings to date have beat expectations, according to FactSet. For the Dow, 11 companies of the 14 that have reported have topped estimates. There’s been “a really healthy earnings picture for U.S. corporations so far,” said Michael Marrale, head of research, sales and trading at brokerage firm ITG.

Investment Implications – Bulls Still In Control

As noted on July 21, recent volatility can be put into the “normal” basket. How concerned should we be about the failure of the S&P 500 to post a new closing high? At this point, it is not something to lose sleep over. Our concerns would increase if stocks have not posted a new closing mark over the next couple of weeks. The evidence in hand continues to call for U.S. equity exposure (SPY), coupled with leading sectors, such as transportation (IYT).

Is Recent Volatility Cause For Concern?

Monday, July 21st, 2014

Earnings: A Big Role This Week

Before we get into the subject of recent volatility, it is important to understand the primary market driver in the days ahead – earnings. From The Wall Street Journal:

Twelve Dow industrials components and 146 S&P 500 companies are set to post earnings this week, including Apple, Microsoft and Ford, according to FactSet. “This is peak earnings season week,” said Doug Cote, chief market strategist at Voya Investment Management. “I’m expecting continued good news. My expectation is that we’re going to handily beat consensus earnings.”

Volatility To Ignore?

In the graph of the S&P 500 below, if markets moved in a linear fashion, managing risk would be much easier. It would be easy to leave our investments alone between point A and point B. It would have been easy to spot that something was changing between points B and C, and much easier to discern something had changed for the worse between points C and D.

Unfortunately, markets are volatile. Therefore, from a risk management perspective it is helpful to have tools that help discern between “volatility to ignore” and “volatility to respect. This week’s video covers the topic in the context of recent volatility in the U.S. stock market.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

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Good Sign For The Economy?

Earnings are not just about numbers. The market is always interested in forward looking statements regarding the economy. Energy producers may be providing some insight. From Reuters:

Halliburton Co (HAL.N), North America’s top oilfield services provider, said it would add fracking equipment and crew to take advantage of higher demand in the region, signaling an industry-wide recovery after a two-year slump.

Investment Implications – Eye On Conflicts

Even with the S&P 500 down as much as 12 points in Monday’s session, support shown in the chart below remained in place.

The markets are dealing with unrest in the Middle East and Ukraine. From The New York Times:

As diplomatic pressure for a cease-fire mounted on the conflict’s 14th day, the Palestinian death toll topped 500 and the number of Israeli soldiers killed hit 25, more than twice as many as in Israel’s last Gaza ground operation in 2009. Two Israeli civilians have also died from rocket and mortar fire.

From a separate New York Times article:

After days of obstruction, Russia-backed separatists in eastern Ukraine permitted Dutch forensics experts on Monday to search the wreckage of the downed Malaysia Airlines jetliner destroyed by a surface-to-air missile, allowed bodies of the victims to be evacuated by train and agreed to give the plane’s flight recorder boxes to the Malaysian government. The movements, four days after Malaysia Airlines Flight 17 exploded and crashed in an eastern Ukraine wheat field, came as President Vladimir V. Putin of Russia faced a growing international clamor to clear the way for a full and unimpeded investigation of the disaster.

The evidence we have in hand continues to call for a prudent allocation to U.S. stocks (SPY), and leading sectors (QQQ). However, with markets nervous about the Fed, geopolitical events, and earnings, flexibility remains as important as ever.

Tuesday brings reports on inflation and housing. Never a dull moment.

Stocks: Volatility To Respect?

Friday, July 18th, 2014

Still Relevant Big Picture Risk Management Articles - Weekend Reading.
More links and charts on Twitter.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

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Video - Check Link

Friday, July 18th, 2014

YouTube is processing a little on the slow side tonight. This week’s video should be available on the CCM YouTube Channel sometime between 7:10 and 9:00 pm EDT.

Most Recent Comments Via Twitter

Friday, July 18th, 2014

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

Most Recent Comments Via Twitter

Thursday, July 17th, 2014

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

New Dow Theory Signal - What Does It Mean?

Thursday, July 17th, 2014

Charts Monitor, Rather Than Dismiss Fundamental Data

Critics of technical analysis often mistakenly believe that using charts discounts the importance of fundamental data, such as earnings, employment, and economic growth. Charts allow investors to monitor the aggregate investor interpretation of all the fundamental data. Said another way, charts are efficient tools used to monitor vast amounts of fundamental data, which is important since fundamentals ultimately determine which assets classes will perform best. When the economy is healthy, stocks tend to beat bonds. When economic fear dominates, bonds tend to beat stocks. In this article, we will cover the latest signal from the markets that came on July 16.

Dow Theory Is Based On Economic Common Sense

Dow Theory is based on a series of Wall Street Journal articles written by Charles Dow. The basic tenets of Dow Theory are easy to understand. Charles Dow believed that:

  1. In order for industrial companies to increase their earnings, they had to produce and sell more goods.
  2. If industrial companies are selling more goods, then transportation companies must be delivering more goods to retailers and wholesalers.
  3. Therefore, in a healthy economy, both industrial companies and transportation companies should be experiencing revenue growth.
  4. If industrial and transportation companies are growing their revenues, then the industrial and transportation stocks should be attractive to investors.
  5. If industrial and transportation companies are doing well and are attractive to investors, both the Dow Jones Industrial Average and the Dow Jones Transportation Average should be making new highs in unison, serving to confirm a healthy economy.

Behind The Averages

After reviewing the companies in the industrial and transportation averages, it is easy to see why they represent logical vehicles to monitor the pulse of the U.S. economy. In 2014, our economy is driven by more than just industrial or manufacturing companies. The present day Dow Jones Industrial Average contains traditional producers, such as IBM (IBM), 3M (MMM), Boeing (BA), Chevron (CVX), and Johnson & Johnson (JNJ). However, the Dow (DIA) also contains Visa (V), Goldman Sachs (GS), and American Express (AXP), since the present day economy relies heavily on the financial sector. The Dow Jones Transportation Average (IYT) still has railroads, such as Union Pacific (UNP) and Norfolk Southern (NSC), but it also contains more modern logistics companies, such as United Parcel Service (UPS), Fed-Ex (FDX), and J.B. Hunt (JBHT).

Just Reconfirmed Primary Bull Market

If investors believe industrial and transportation stocks are healthy and thus, attractive investments, that speaks to demand. When demand is strong, stock prices rise. Despite the recent Fed/Ukraine volatility, the Dow Jones Industrial Average posted a new closing high this week. Notice the slope of the blue 50-day moving average in the chart below; you can compare it to the early stages of a 2011 correction in stocks and to the 2008-2009 bear market later in the article.

Similarly, the Dow Jones Transportation Average also posted a new high on July 16. Again, note the look of the blue 50-day moving average.

2011: How Can This Help Us Manage Risk Today?

If Dow Theory offers a way to monitor the aggregate interpretation of the economy, earnings, and central bank policy, then we would expect charts of the DJIA and DJTA to be helpful in terms of managing investment risk. Since a picture is worth a thousand words, when the Dow’s 50-day rolled over in 2011 (see orange arrows below), the index dropped an additional 16%. Notice how the Dow failed to make a new closing high before the big reversal in 2011. As of July 17, the 2014 Dow chart looks much better (slope of 50-day is up, recent higher high).

2007-2009: Economic Pessimism And Investor Fear

Similar economic warnings came in 2007 and 2008 (see orange arrows in chart below). Notice during the 39% drop in the Dow in 2008 the 50-day never gave a “things are improving” signal, meaning it was helpful from a cash-redeployment perspective. The Dow was not making new highs; instead it was making a series of lower lows, which reflected a period of economic pessimism and investor fear. The 2014 chart looks much better, which is indicative of more favorable economic expectations.

The differences are easy to see side-by-side. The stronger bullish conviction tells us even if stocks pull back in the short-run, the odds are good that buyers would step in and attempt to test the recent highs. Reversals tend to be a process rather than a one day binary event. The charts below speak to probabilities.

The Fed Still Big Part Of Fundamental Equation

Anyone that has followed the markets closely, especially over the last four years, knows that all things being equal the stock market is not fond of any Fed move that slows the printing presses. Thursday’s not too hot, nor too cold data on the economic front most likely keeps a 2015 rate hike on the probability table. From Reuters:

Rising inflation pressures could push the U.S. Federal Reserve to raise interest rates as early as the second quarter of next year, according to a Reuters poll of analysts. America’s jobless rate sank to almost a six-year low in June and consumer prices posted their largest rise in May in more than a year, bolstering the belief that the U.S. economy is turning a corner. Now many Fed watchers are bringing forward forecasts on the timing of when the central bank will raise interest rates. “All things considered, there is now an increased risk of an earlier first rate hike,” economists at Bank of America Merrill Lynch said in a report.

Investment Implications – Time To Pay Closer Attention

Does the recent Dow Theory bullish confirmation mean it is all fun and games for the economy and stock market? No, it simply tells us the market is currently healthy, and the next bout of significant weakness is more likely to be a correction, rather than a full blown bear market. Notice, a correction remains a possibility. As the godfather of technical analysis noted on Twitter, this week’s signal keeps the longer-term bullish case intact.

For Further Study

Since the markets are nervous about rising interest rates, it may be prudent to brush up on risk management strategies:

  1. How To Monitor The Risk Of A Midterm-Election-Year Stock Correction
  2. 5 Reasons Your Simple Bear Market Plans Could Backfire
  3. The 2 Most Important Questions For Investors

Sentiment: A Meaningful Shift For Stock Bulls?

Thursday, July 17th, 2014

Hot Off The Press

On July 16, in a review of investor sentiment, we noted the importance of keeping an eye on this week’s American Association of Individual Investors (AAII) Sentiment Survey. Last week’s decline in the S&P 500 and this week’s concern over a 2015 rate increase by the Federal Reserve, has resulted in a rational decrease in bullish sentiment and an increase in bearish sentiment. The image below is a screen shot from AAII’s website:

Sentiment Is Not At Extreme Levels

If you are new to sentiment, the basic theory is as follows…if we see excessive bullishness, it means most investors are probably close to fully invested. Conversely, if we see excessive bearishness, then most people have probably sold already. If everyone has bought, then buying power becomes weak. If everyone has sold, then selling pressure drops. Thus, theoretically, sentiment can be helpful when it reaches extreme levels since the probability of a market reversal is higher.

Bullish sentiment is currently below average (32.4% vs. 39.0%). Similarly, bearish sentiment is hovering around average, not extreme levels. Therefore, in theory, sentiment is not particularly helpful at the present time. Sentiment is certainly not at extreme levels that would suggest an imminent major peak in stocks. A correction is the more likely outcome if markets become weak.

Investment Implications – Wait For Evidence To Turn

The following tweet contains arguably the most important concept in investing and risk management:

The concept above applies to the present day market. Does the tweet contain useful information? We think so and others have agreed by voting our firm “most helpful” on Twitter. In terms of how to deal with recent volatility in the stock market, note in the tweet it says nothing about forecasting. Over the next few weeks, if we pay attention meticulously and make adjustments as needed, our allocation between stocks (SPY) and conservative assets, such as bonds (TLT) will stay prudently aligned with the stock market’s upside potential relative to the downside risks.

Investor Sentiment: Actions Speak Louder Than Words

Wednesday, July 16th, 2014

Are Investors Wildly Optimistic?

While you can find things to be concerned about on the sentiment front, if an individual investor was highly optimistic that the U.S. market would push higher, we would expect to see net inflows into U.S.-based stock funds. Said more directly, if we “knew” stocks would be higher in three weeks or three months, most of us would stay in stocks. According to recent data, investors are not as optimistic about the stock market as many believe. Facts from Reuters:

Investors in U.S.-based mutual funds pulled $7.8 billion out of stock funds in the week ended July 2 on fears of an early rate hike from the Federal Reserve, data from the Investment Company Institute showed on Wednesday. The net outflows from stock funds were the biggest since the start of last year, according to data from ICI, a U.S. mutual fund trade organization. Funds that specialize in U.S. stocks posted $8.9 billion in outflow.

We Live In A Global Economy

Stocks across the globe tend to move in unison, which means equity prices in Germany are highly correlated to the in the United States.

If stocks were on the verge of a myopic peak, we would expect, at least from an anecdotal evidence perspective, that investors around the globe would be highly optimistic about owning stocks, especially in a large developed nation, such as Germany that correlates so highly with the S&P 500. Is that what we have now? From The Economic Times:

Investment sentiment in Germany fell to the lowest level for 19 months in July amid signs of a dent in activity in Europe’s top economy, a survey found on Tuesday. The widely watched investor confidence index calculated by the ZEW economic institute fell by 2.7 points to 27.1 points in July, it said in a statement.

Economically Sensitive Stocks Holding Breakout

On July 2, we penned the following:

The weekly chart of consumer discretionary stocks is trying to nail down a new all-time weekly closing high this week, which speaks to improving economic confidence.

The updated version of the chart shown on July 2 shows the bullish push higher is still holding above previous resistance. As long as the consumer discretionary ETF (XLY) holds above 67.06, all things being equal it is a good sign for stocks and the U.S. economy.

AAII Sentiment Survey

We noted on June 9 that AAII sentiment readings were not alarming. How do they look now? While this week’s figures are worth watching, as of 7/9/2014, the bullish sentiment of 37.6% was still below the long-term average of 39.0% (hardly alarming).

Investment Implications – Still Long

Since the topic of investing in individual stocks is outside the realm of our normal base of topics, you may have missed “Retirement: Are You Exposed To False Diversification Risk?” The article illustrates a few points that are relevant for all investors:

  1. Bear markets occur on a fairly regular basis, and they are never fun.
  2. The vast majority of stocks decline in a bear market, even blue chips.
  3. If we know 1 and 2 above, then it is prudent to develop specific and actionable plans prior to the onset of the next “surprisingly painful” period that features bears controlling the stock market.

In last week’s video, we made the case for staying with stocks. Since the S&P 500 is up 13 points this week (as of Wednesday afternoon), the bullish case remains intact. Therefore, we continue to hold U.S. stocks (SPY), and leading sectors, such as technology (XLK). As of 1:20 p.m. EDT Wednesday, SPY has gained 0.68% this week; XLK has tacked on 1.62%. As always, we will monitor the incoming data with a flexible and open mind. Thursday’s economic docket features reports on housing, employment, and manufacturing.

Retirement: Are You Exposed To False Diversification Risk?

Tuesday, July 15th, 2014

Retirement: Is Your Due Diligence Complete?

While building a growth-and-income portfolio for retirement, many investors have properly addressed steps 1, 2, and 3 in the list below. As we will demonstrate via step 4, portfolios consisting of a diversified basket of blue-chip dividend payers may leave investors exposed to higher than anticipated risks in a bear market. Therefore, adding step 5 to your prudent dividend approach can improve your odds of protecting and growing your retirement nest egg in both bull and bear markets.

Due Diligence Steps

  1. Secure income using Dividend Champions screen.
  2. Diversify across all major S&P 500 sectors to reduce volatility and risk.
  3. Check valuations and fundamentals.
  4. Check portfolio’s performance in bear market.
  5. Develop a specific exit strategy/risk management plan.

A Well-Constructed Portfolio

Since our firm focuses on all asset classes and market sectors, we will let the retirement experts help us build a prudent growth-and-income portfolio to use as a basis for this risk management exercise. Since the benefits of dividends are well documented and many retirees need income, we started with an excellent list, the Dividend Champions. The vast majority (88%) of the stocks in our hypothetical portfolio (see below) are current Dividend Champions. We also used Chuck Carnevale’s excellent fundamental screens to help us with the security selection process. The vast majority (83%) of our portfolio below passed one of Mr. Carnevale’s relatively recent screens, which can found in these articles:

  1. Is Dow 17,000 Dangerously High?
  2. Protecting Your Income Portfolios
  3. 20 Dividend Champions To Buy Today

In the table below, if the column Pass Recent Value Screen? has a “yes”, the stock appeared and passed screens in one of the three articles above. We added a few stocks outside the screens for diversification purposes. We wanted to have at least two stocks from each major S&P 500 sector. Since financial stocks tend to perform well on valuation and income screens, we added a couple of extra consumer staples stocks to offset the added risk of over-weighting financials. The portfolio consists of Target (TGT), Genuine Parts (GPC), Altria Group (MO), Procter & Gamble (PG), Wal-Mart (WMT), Archer Daniels Midland (ADM), Chevron (CVX), Exxon Mobil (XOM), AFLAC (AFL), Franklin Resources (BEN), Community Trust Bancorp (CTBI), Eaton Vance (EV), Johnson & Johnson (JNJ), Medtronic (MDT), Stanley Black & Decker (SWK), 3M (MMM), HB Fuller (FUL), PPG Industries (PPG), Automatic Data Processing (ADP), International Business Machines (IBM), AT&T (T), Verizon (VZ), Consolidated Edison (ED), and Southern Company (SO).

STEP 4: Test Portfolio In Bear Market

In the minds of many investors, one of the objectives of investing in established blue-chip stocks is to reduce risk in next inevitable bear market. The table below shows the performance of each stock during the last bear market.

STEP 5: Building A Risk Management Plan

The excellent list of Dividend Champions and fundamental screens are value-add steps in the due diligence process. However, the next logical question is:

How does an investor manage the portfolio when the next bear market arrives?

One possible answer is via a buy-and-hold strategy, which sounds good on paper, but is much, much harder to implement in the real world where you have to sleep at night.

Do You Have The Stomach For Buy And Hold?

How difficult and stressful would buy and hold have been day-by-day in the 2007-2009 bear market? To answer that question, we collected the daily adjusted closing prices (accounts for dividends) for each stock in our sample portfolio. The graph below assumes we had $500,000 allocated in equal amounts of $20,833.33 to each of the 24 stocks in the retirement portfolio. The maximum drawdown on the $500,000 portfolio during the last bear market was roughly 40%, which means what once was a $500,000 portfolio dropped to a low of roughly $300,000 in March 2009.

The purpose of the article is not to say buy and hold is not a relevant option for all investors, but rather to educate blue-chip investors on the potential downside risks of a buy and hold approach. It is stressful to see your $500,000 drop to $300,000. Many investors approaching retirement or in retirement have no desire to ride out a 40% drop. If you consider yourself in that group, then building a risk management/bear market contingency plan is a logical next step.

2008: There Was Nothing You Could Do, Right?

Just because you have been told there was nothing you could have done in 2008, that does not mean it is true. Markets are difficult. Investing is difficult. However, as outlined in this 2008 video, paying attention to observable evidence could have improved an investor’s odds of mitigating (not eliminating) risk in the last bear market.

2003-2008: An Example With A Blue Chip Stock

Just as the 2008 video referenced above covers concepts and does not represent a complete portfolio management system, the same remarks apply to the hypothetical risk management example that follows. Our real world risk management system answers thousands of questions about the market, but we can explain the conceptual use of observable evidence as a risk management tool by answering three questions about Target (TGT). In our simplified system, we can only buy Target when all three answers to the questions are “yes”. We can only sell Target when the answers to all three questions are “no”.

  1. Is the price of Target above the 200-day (in red below)?
  2. Is the slope of Target’s 200-day positive?
  3. Is Target’s 50-day (in blue) above the 200-day?

The first time the answer to all three questions was “yes” in the chart below came when Target was trading at $28.80 in 2003. Assume we bought Target at $28.80. Now, we can only sell Target when all three questions are “no”. Notice during the entire move from $28.80 to $46.46 (a 61% gain), we never get a sell signal. Yes, price dropped below the red 200-day in 2004 and 2005, but the answer to the other two questions were still “yes”. We can only sell when all three answers are negative.

Simple Example Of Risk Reduction

The observable evidence (no predictions needed) hit “sell mode” in November 2007 (see below). After the sell signal Target fell from $45.66 to $22.72. Even this very simple system would have avoided holding Target during a 50% loss.

The chart below zooms in on 2008, showing the observable evidence clearly said “you cannot buy Target” when most investors were not sleeping very well. Yes, price went over the red 200-day in August 2008, but the answers to the other two questions were still “no”, meaning our rules would not have allowed us to repurchase Target in 2008.

Are The 50-Day And 200-Day Perfect?

No, in fact, no moving average, indicator, or ratio represents the holy grail of risk management. Since the 50-day and 200-day can produce whipsaws from time to time, we do not recommend building a system based on these inputs only. However, the moving averages shown here do add value and can be used in conjunction with other “this can improve our odds of success” tools to build a diversified risk management system. This flow diagram is an example of using multiple hard and unbiased inputs on numerous time frames in a diversified manner.

More On Risk Management Systems

If you want to get your creative juices flowing and expand on the concepts presented above, the following articles may be of interest to you:

  1. You Will Never Look At The Markets The Same Way Again
  2. Tired Of Missing Rallies? 4 Ways To Improve Your Game
  3. 5 Reasons Your Simple Bear Market Plans Could Backfire
  4. The Most Important Thing For 2014
  5. With The Fed Stepping Back, Your Portfolio Needs You To Step Up And Lead

Investment Implications – A Few More Due Diligence Steps

To recap, many investors have checked most of the right boxes below:

Many investors have not completed the last two steps in the table above. The objective here is not to fear monger, but rather to encourage risk management reviews while the bull market sun is still shining. Once risk management plans are in place, the odds of sustaining hard-to-recover from losses will be reduced, not eliminated. All investing involves risk and uncertainty, but there are ways to reduce risk and uncertainty.

Can We Stock Pick Our Way Out Of A Bear Market?

It should be noted, we do not own any of the 24 stocks included in the hypothetical retirement portfolio, and do not have any plans to buy them, nor are we recommending them as possible investments. They are presented here for illustrative purposes. Numerous studies have found that roughly 90% of the investment battle is based on allocations (% stocks vs. % bonds) and only roughly 10% is based on picking individual stocks or companies. Said another way, it is very difficult to stock pick your way out of a bear market since most stocks drop. The results above align with these studies (23 of the 24 stocks lost money in the 2007-2009 bear market). More on allocation vs. security selection can be found here.