Equity Portfolio Activity for the week ended April 22, 2016

Equity Portfolio as of April 22, 2016

Commentary: This was a very uneventful week. I did not take any action in the markets for I saw nothing to buy at the current prices. I easily saw things to sell at these prices, but I did not sell as I believe I now reside at the lower threshold of my desired equity allocation. The individual price action as the week came to a close saw meaningful declines in some of the more notable names, and the drumbeat around investing for dividends vs price appreciation is louder than I have heard in a long-time. Given the price risk with equities, I do not advocate buying here, even if dividends offer a better return than fixed income. For me, that is a transient state and I would rather earn great dividends off of great buying opportunities than to chase dividends at any price. Be careful out there.
Good Luck and have a great week!

New Additions Continue reading “Equity Portfolio Activity for the week ended April 22, 2016”

Mission Statement for 2016

Sunday, January 3, 2016

Mission Statement: To generate financial returns on invested money that meet the goal of providing greater financial resources and flexibility for the future. This goal is a self-serving one and is therefore not sufficient in meeting my wish to be of help to others. Therefore, there is a second part of this Mission Statement, and that is to openly share in a very transparent manner the weekly investment decisions I make and the reasons why I take the actions I do. My hope is that by doing so I will provide others with a perspective that may add to the factors they consider in establishing their own financial plan for their future.

Closing and Opening Comments for 2015 and 2016, respectively.

The year 2015 closed with a final full year return of 11.6%.

I am pleased with the overall performance in the past year, but, and this is a meaningful BUT, it should have been so much better. The value of education is immeasurable, and for me, the October 2015 period found me positioned incorrectly with my Short E-Mini and Put option choices. After the poor employment report at the end of September, I kept a material short hedge in place that in hindsight I wish I had taken off once the market told me it was headed higher, and it did tell me, BUT I ignored the Market Tells. What should have been a full year return of in excess of 20% settled at a positive return of 11.6%. Good, but not good enough given my models and analyses provided me with the indicators that, if followed in that October period (consistent with my approach during the rest of the year), would have enabled me to do better for the full year.

As I look to the year 2016, I am targeting a return of greater than 15%. Why do I see this as being attainable? There are a number of reasons and they are as follows:

1. For the first time during my professional life, I will commit 100% of my time and effort to investing. Retiring from Ernst & Young as a Senior Partner in December 2015, now enables me to focus completely on my investing passion. My business experience is extensive, and that experience will now have a singular focus, building net worth through a studious and knowledgeable focus on something I love, the puzzle and opportunity of the market.

2. My financial models reflect 30+ years of data analysis. These models range in focus from long-term, to medium term, to short term. They cover economic trends (U.S. economy, interest rates, money flows, and FX), overall equity market internals, detailed analysis on 187 companies, including cash flow, operating margins, balance sheet strength, relative market value, dividends, price movements, and industry performance, and finally, asset class strengths/weaknesses. When interpreted in a coherent and collective manner, the guided investment choices are consistently accurate in generating above average returns.

3. The acceptance that I will be wrong at times, and the wisdom to know it is not about being right and wrong as much as it is about being right more than wrong and most importantly, how great my returns are when right and how limited my losses are when wrong. Management of the portfolio is the most paramount charge, and in my waking moments this will be my focus each and every day.

4. Because investing is what makes me happy. Intellectually challenging, emotionally full, and demanding of self-control are the attributes that drive me, and success in the market demands the highest level of performance in these areas. I know that investing is where I will receive a report card every day, and I expect to receive “A’s”.

Going forward the readers of this Blog will find the following on a weekly basis:

• The prior weeks purchases and sales of individual equities and a complete listing of the stocks currently owned. Additionally, I will provide a recap of the returns on my portfolio and on the market returns YTD, coupled with my view of the investing questions that must be answered with the outlook for the coming week.

In addition to the weekly report and commentary, I will provide:

• A periodic commentary on what I call the “Lab”. The Lab will discuss economic trends within the United States
• A periodic commentary on what I call “Trends” Trends will discuss weekly market movements and the confirmation or lack thereof of the movement in index averages.
• A commentary once every quarter of the composite themes coming from the analysis of the 187 companies within my database called “Equity Analysis”.
• Various other posts that may have relevance given the twists and turns of the macro or micro environments in which we live.

As I close this first post of 2016, I wish you all well, wanting happiness, success, and joy for each and every one of you that read this blog.

Now let’s go make some money……………………

Tom

Seeking Diamonds in the Rough

Tom Connolly’s Equity Market Forecast

for the upcoming week beginning April 18, 2016

With Market Questions and Answers

 

Summary Comments:

This week’s write-up will be relatively brief given the time required to complete my 2015 Federal and State tax filings.  A fuller version will be back next week.

Equities continue to lack appeal for me.  The tug of war between wanting to own great companies and the price of choosing to act on that desire dominates my view of the market.  At the current multiples of earnings and cash flow, the market is very expensive based on historic comparisons.  This would be justified if we were experiencing significant growth and growth opportunities, but that robust environment is just not evidenced in the economic results to date.

As I walk through the streets of Manhattan I am struck by the expanding number of retail outlets that have closed and for which the space is available for lease.  When I inquire of others that live outside of Manhattan as to their observations in regard to retail, I hear the same observation.  When looking at the residential real estate market in New York, it is clear the bloom is off the rose this Spring.  Properties are not moving, volume and price are down.  The professional service firms appear to be slowing in their growth as we see more and more financial and advisory firms reducing their workforces.  Regulations, cost of doing business, and the tax and health care cost burdens are taking a toll.  I not only see this in my readings, conversations, and walks about town, but I am experiencing it first-hand in my own cost of living (as I work on my tax return, presently my tax bill for 2015 looks like it will be close to 40% of income).  The cost burdens that continue to expand, many targeted to fund transfer payments in the United States, are not adding productivity, but are expanding the drain of capital away from expansionary economic undertakings.  With this as the backdrop, I scratch my head at a market that sees the S&P 500 trading at 24X current earnings and at 17.7X forecast earnings.  At a cash flow multiple of 18.3X forecasted 2016 results, and with 2016 and 2017 forecasted cash flow growth below the historic growth rates of the past.  The returns on investment do not justify the prudent deployment of capital in the current environment. 

Based on an assessment of United States reported economic data, my models show negative results for Economic indicators, Interest rate indicators, Market value indicators, and FX indicators.  The only positive is the money indicator, and that has been positive for so long.  The data is telling us that the stimulative impact of money was present for a time, but now lacks positive value generation. The lack of economic growth indicates diminishing returns. 

Finally, from a technical perspective the market behavior is positively endorsing the holding of stocks.  I scratch my head here, but cannot ignore the support of higher flows into advancing stocks.  My concern for a headfake is real, but maybe, just maybe, the market is telling us that better economic results are in our future.  I wait with bated breath.

Given this perspective, I am studying all of the tea leaves in search of hard facts, hoping to find diamonds in the rough.  They seem very hard to come by.   The portfolio and market performance report for the YTD period ending on April 15, 2016 is as follows:

 

YTD Connolly portfolio gain as of April 15, 2016 equals        +5.78%

S&P 500 Index YTD gain as of April 15, 2016 equals              +1.80%

NASDAQ Index YTD loss as of April 15, 2016 equals              -1.38%

 

Portfolio composition as of April 15, 2016 is as follows:

  • Cash                   51.1%
  • Equities             34.9%
  • Gold                    12.2%
  • Fixed Income      1.8%

 

Have a great week!

Tom

Equity Portfolio Activity for the week ended April 15, 2016

Equity Portfolio as of April 15, 2016

Commentary:  All last week through Thursday I sat on my hands and did nothing.  On Friday, I once again made the decision to take more gains off of the table and below you will see some of the companies that I sold.  I am frustrated by the conflict of the technical behavior (confirming the advance) to the fundamental value of the market (expensive).  I just cannot buy equites now without feeling as though I am taking on too much risk vs the potential reward.  The market is behaving as if strong revenue and earnings growth is coming and I am doing my darndest to try and see it.  Maybe I need new eye glasses.  Best if I just go for a run around the Central Park reservoir and let the mind float as I seek a catalyst to get me more in rhythm with the movement of the market.  Happy with what I own and very optimistic for the longer term returns, but right now the best counsel is to be patient and ready for the meaningful opportunities that the future will offer.

Good Luck and have a great week!

New Additions

  1. None

Increase in Holdings

  1. None

Complete Dispositions

  1. Navigant Consulting – Closed position

Partial Decrease in Holdings

  1. Brocade Communications – Reduced position
  2. GreatBatch – Reduced position
  3. Greenbrier – Reduced position
  4. Nucor – Reduced position
  5. Olin Corp – Reduced position
  6. Synaptics – Reduced position

 

Overall Equity Portfolio holdings 

  1. Alamos Gold
  2. ASA
  3. Arm Holdings
  4. Alibaba
  5. BB&T Corp
  6. Brocade – Reduced position
  7. Brookfield Total Return
  8. Chevron
  9. Con Ed
  10. Costamare
  11. CISCO
  12. Corning
  13. Disney
  14. Eastman Chemical
  15. Endo Int’l
  16. Ericsson
  17. First Solar
  18. Ford
  19. Frontline
  20. General Electric
  21. GLD
  22. Golar LNG
  23. GreatBatch – Reduced position
  24. Greenbrier – Reduced position
  25. Halliburton
  26. Hecla Mining
  27. Hershey
  28. Ingredion
  29. JP Morgan
  30. Matson
  31. Microsoft
  32. MTN Group
  33. Navigant Consulting – Closed position
  34. New Gold
  35. Nokia
  36. Nordic American Tanker
  37. Norfolk Southern
  38. Nucor – Reduced position
  39. Olin Corp – Reduced position
  40. PayPal
  41. Phillips 66
  42. Qualcomm
  43. Reaves Utility Income Fund
  44. Synaptics – Reduced position
  45. Ten Cent Holdings
  46. Travelers
  47. Twitter
  48. Viacom
  49. Wells Fargo
  50. Yum! Brands
  51. Zimmer Biomet Holdings

Separating the Wheat from the Chaff

Tom Connolly’s Equity Market Forecast

for the upcoming week beginning April 11, 2016

With Market Questions and Answers

Summary Comments:

My sense of risk vs reward is one where I believe the risk is much greater than the reward.  Accordingly, I was a net seller of equities and fixed income this past week, locking in gains and further increasing my level of cash.  The equities I sold do not reflect a view that they are fully-valued or over-valued.  I think they have much higher highs in their future, but it is my belief that the odds favor a near-term overall market decline.  That belief requires me to pair back the companies I see great value in for they will be bought back again, but at prices that are lower than today.  

There are many reasons why I am moving to the near-term bearish side.  A couple of data points will highlight my concern.  The companies within the 187 Equity Portfolio closed on Friday with a strong negative indicator that troubles me.  This indicator is very simple and not formula based.  I compare the current closing price of the portfolio to prior price levels to identify periods when values are similar.   I then look to see how many of the 187 companies are lower in price given the same portfolio value.  The expectation is that the percentage of companies within the portfolio that are lower in price at each comparison date should be approximately equal given the closeness of price at those various points in time.  On Friday, April 8th, the percentage of companies with prices lower than the December 31, 2015 price was 46%.  On March 18th the percentage was 39% but the price was effectively the same.  The 46% vs the 39% at the same price level tells me something is changing, and not in a positive way.  Secondly, a similar event exists for the March 25th comparison, only here both the price and the percentage were lower than the April 8th amounts.  This should not happen in a balanced market as these measures should move in opposite directions (a portfolio price rise should be supported by a decline in the number of companies that have negative price trends, not an increase). This indicates that the broad based price increases we saw after the February declines were driven largely by short covering in an indiscriminate manner, and now the process of separating the wheat from the chaff is taking place in an environment where there is great global uncertainty.  It is a dangerous combination, particularly when the current market value metrics indicate the market value is above the historic means and medians.  While the above summarizes my overriding sense of caution, it is very important to note that the market internals over the past week and in fact over the past two weeks do not support a continued decline.  In fact, they are pointing to a reversal of the index decline from this past week.  Conflicting signals are a regular part of the market, and that is why it is hard to truly generate above market rates of return.  With such conflicting signals the need to act prudently is paramount if we are to achieve success in these financial markets.

Given this perspective, the actions I took this week are reflected in the portfolio performance and the resulting period-end portfolio allocation that is set forth below.   The portfolio and market performance report for the YTD period ending on April 8, 2016 is as follows:

 

YTD Connolly portfolio gain as of April 8, 2016 equals        +5.55%

S&P 500 Index YTD gain as of April 8, 2016 equals              +0.18%

NASDAQ Index YTD loss as of April 8, 2016 equals              -3.13%

 

Portfolio composition as of April 8, 2016 is as follows:

  • Cash                       52.0%
  • Equities                  34.6%
  • Gold                        11.6%
  • Fixed Income           1.8%

Forecast for the week:   First quarter earnings announcements will begin this coming week and will continue over the month of April.  The first quarter 2016 U.S. economic data has been weak, and the continued recessionary pattern of factory data coupled with disappointing data on Wholesale and Retail sales should begin to weigh on the market.  Actions by Central Banks are consistently providing smaller and smaller benefits, and the Financial Sector lacks any catalyst to support the overall market as interest spreads and IPO/Deal activity are not providing any earning acceleration.  In fact, the interest rate environment and the lackluster capital raising activities have created an earning deceleration event within the market.   Given the above, I believe we are moving to a place where the expectation of a cathartic move is once again an appropriate consideration in the development of a successful investment plan.  I say this because if we are to bring order and alignment back to market values, values that are fairly based on realized and prospective performance, then the market needs to re-establish an investible base from which to grow that is consistent with historic rates of expected return.  The first quarter revenue and earning reports will most likely show negative growth, and while these reports provide a backward looking assessment, the forward look is likely to be troublesome given the expected modest to down growth forecasts that will accompany the first quarter reports.  Additionally, the recent negative behavior of the Dow Jones Transports, an Index which has provided advance notice of broader market moves higher and lower over the past year or so, is foretelling a continued softness in economic growth.  All of this coupled with the continued weakness in global markets provide the backdrop for my assessment of high risk in the current equity market.

In this environment I continue to maintain an E-Mini short position, and will look to increase it if I continue to see the market weaken.  I have a healthy allocation to precious metals primarily through holding equites in the Miners.  The Miners have more than doubled in price since the beginning of the year and the momentum continues to be in place (the position is partially hedged with inexpensive put options).  Finally, I maintain an array of strong dividend generating equities. 

For the upcoming week, I expect volatility and uncertainty to become more pronounced.  The overall market pattern indicates to me that the market move higher is tiring, and that the tilt of the market is to the downside which may accelerate quickly.  The highflyers of Amazon, Netflix, Facebook, Apple and Google will be tested this quarter.  The damage done in the bio-tech and healthcare space is not over, and has not been helped by the United States Treasury ruling on M&A tax inversions and earning stripping tactics of foreign based companies.  I think this ruling has not been fully absorbed by the market in terms of its depressing effect on M&A, and this may be the catalyst that once again sees government actions and regulation undermining the growth opportunities of the companies comprising the most meaningful value areas in the marketplace.   My conclusion: “Be very careful out there”. 

 

Market Questions and Answers

What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?

The DJIA, NASDAQ and S&P remain in over-bought territory, but the decline in the past week took some of the excess out of the market.  The 12-week Relative Strength readings are 75 for the DJIA, 71 for the S&P, and 67 for the NASDAQ (RS in the 30s and below typically indicates an oversold market and hence a buying opportunity, while north of 60 typically indicates overbought conditions and a selling opportunity).  It makes sense to expect a continued market pullback as the Relative Strength loses upward momentum and gravitates back to a more balanced or even over-sold condition.  In isolation, I would be mindful of the RS level but not use it as the decisive indicator for investment actions.  But at these valuation levels, and with the troublesome macro-events taking place, market sentiment could turn quickly, and if it swings to the negative side, the declines could accelerate in an abrupt manner.   This makes me more sensitive to the RS level in making investment decisions that are strongly influenced by the likelihood of the market being near a turning point.

The DJT continues to lead the market trend.  It peaked on March 18th, and for the past three consecutive weeks it has declined.  As I wrote last week, the DJT is often the canary in the coal mine, so pay attention to the daily/weekly changes here. 

The DJU continues to be strong reflecting the safety of yield in a nervous world of Central Bank easing and Negative interest rates on foreign government debt.  It did pull back this week as the run higher has become extended.  Profit taking dominated the action.  Keep an eye on this index as it presently gives an indication of investor pursuit of safety rather than economic expansion (economic expansion would be evident if electric usage was accelerating thereby driving Utility profitability, and electricity consumption is not expanding at this point).

 

What is the current score on the Market tells metric?

The Market Tell indicator, which is a comparison of the market’s current cash flow and valuation metrics to its historic medians, closed the week at negative 31 as compared to last week’s reading of negative 58 (meaningfully lower than its high reading of +44.8 when the market made significant lows on February 12th).   When we have a high positive reading this is a strong buy signal and when we have a high negative reading it is a strong sell signal.  The Portfolio’s Cash flow multiple based on expected 2016 full year results is 17.97X as compared to last week’s 18.44X.  These are relatively high readings of price to cash flow when compared to the historic median of 16.8X.  Comparing current equity prices as the week closed on the 187 portfolio companies to their Discounted Cash Flow values indicates 68 companies were priced above their DCF value, which exceeds the historic average of 60 for the portfolio.  This supports an expected fall in the market as more companies have become overvalued.  I should note that at December 31, the number of companies in this category totaled 72 prior to the January decline.  The dollar spread between the Current Price and the Forward DCF price utilizing 2017 cash flow projections on the 187 portfolio has narrowed and is now at $19.40, pulling back from the February high of $25.14.  Of concern is that the dollar spread based on 2016 cash flow projections is $11.43, which is below the historic median.  This indicates below trend growth in 2016, and an optimistic view for 2017.  Given the wider level of variability that comes into play the further we project into the future I am concerned that the above trend multiple of cash flow which currently exists is giving too great a weight to events that are beyond the current year.

 

What is the position of the net up down Vol/Issues? 

The week’s volume and issues were contra-indicators.  This is important to discuss and to assess its implications.  The market indexes declined this week in a manner that was NOT supported by the declining volume and the number of declining issues.  In fact, the volume and issues point to a coming reversal of this week’s declines in the indexes.   A bit of a quandary here.  In fact, this behavior makes me cautious in being too aggressive on the short side.  As a result, I do not plan to increase my short exposure based on the current facts, but will monitor these two elements more than any other in the coming days and weeks to either add support to my bearish thesis or to tell me to reverse course and get more aggressive on the long side. 

 

What are the daily point vs issues and point vs volume measures indicating up or down? 

The daily metrics of (1) index point moves vs the volume in rising and falling issues, and (2) the index point moves vs the rising and falling number of issues traded, were consistently positive and supportive of a market that should move higher.      

 

Where are the New Highs and Lows moving toward?

Confirmation of a positive trend continues to be evident as New Highs are on the rise.  Actual net new highs for the past five days came in at a cumulative net of 484 new highs over new lows during a week when the market indexes went down.  Similar to the discussion above on Volume and Issues, this is counter to the overriding view I have that the next move will be lower.  Need to be careful here.

 

How well are Market Tells correlating with Market trading internals?

Technically, the 5-day activity in volume and issues is supporting rising prices.  The fundamentals of the Market are indicating a different story. From a trading perspective the technical attributes of the market point to a short term continuation of the rise in value, while the Fundamentals point to a longer term valuation issue that I believe the market is getting close to acknowledging, particularly when current earnings for the first quarter and forecasts for the balance of the year come out during April.  If the valuation concern begins to dominate trading, the technical indicators will quickly flip from positive to negative.  Time will tell if this view has merit.     

 

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation (“CEDATEV”)?

The reading is -3 as compared to last weeks’ assessment of +1.   Contributors are:

 Negative in the following areas:

Calendar

Valuation

Duration

Trend

Positive in the following areas:

Action

Neutral in the following areas:

Environment

Emotion

Other:

Bitcoin is at $418 and continues to show stability.  I hold a position in Bitcoin as we move ever closer to digital currencies vs paper money and coinage.  Please note I also own PayPal given the success and penetration of the Venmo platform. 

Gold was volatile on the week and showed an improving trend as it closed the week in the $1,240 per ounce area.  Miners were up meaningfully, breaking prior resistance levels in a trend that looks like it will continue. 

The Ten-year bond yield closed at 1.72%, down from 1.78% last Friday.  The Fed’s dovish commentary and the relative spreads between US rates and foreign rates continues to exert downward pressure.  Additionally, the relative weakness in the dollar is contributing to the downward move in yields and the upward move in commodities.  For the week, the CRB index of commodities rose to its highest level since September 2015, and this helps the Emerging Markets navigate the economic challenges of being resource providers to the world markets.

The High Yield vs Investment Grade spread continues to be supportive of rising equity values. The spread between HY and IG closed on Friday at 4.924%. The HY closing quote on Friday was 7.885% vs the Investment Grade close of 2.961%.  These are all positive moves for the market that have occurred over the month of March into April.  The debt market is indicating that the higher expected rates of default is now lower than what was previously thought.  If accurate, that is a positive sign for the market.  We do need to keep an eye on developments in the oil patch for any re-emergence of HY concerns and potential spillover into the broader markets.  Presently, there is support for crude oil priced in dollars as the dollar weakness provides a backstop.  Actions from OPEC and the decline or increase in the number of operating rigs in the US remain key to future price movements. 

Have a great week!

Tom

Equity Portfolio Activity for the week ended April 8, 2016

Equity Portfolio as of April 8, 2016

Commentary:  As the week came to a close and the DJIA was up over 100 points on Friday, I decided to further reduce positions and lock in some gains.  I have no desire to sell more of my holdings, but given the market dynamics and my desire to be positioned to capture future buying opportunities, creating a larger cash position was appropriate.  Market fundamentals discourage me from new long positions.  There are equities I want to buy, but must wait for a better entry point. Patience continues to be my counsel in this current range bound market that appears to be heading for a break-out.  My trading speaks to my view that the break-out will be to the downside.

Good Luck and have a great week!

 

New Additions

  1. None

 

Increase in Holdings

  1. None

 

Complete Dispositions

  1. None

 

Partial Decrease in Holdings

  1. Brocade Communications – Reduced position
  2. Brookfield Total Return – Reduced position
  3. Greenbrier – Reduced position
  4. Microsoft – Reduced position
  5. Nucor – Reduced position
  6. Reaves Utility Income Fund – Reduced position

 

Overall Equity Portfolio holdings

  1. Alamos Gold
  2. ASA
  3. Arm Holdings
  4. Alibaba
  5. BB&T Corp
  6. Brocade – Reduced position
  7. Brookfield Total Return – Reduced position
  8. Chevron
  9. Con Ed
  10. Costamare
  11. CISCO
  12. Corning
  13. Disney  
  14. Eastman Chemical
  15. Endo Int’l
  16. Ericsson
  17. First Solar
  18. Ford
  19. Frontline
  20. General Electric
  21. GLD
  22. Golar LNG
  23. GreatBatch
  24. Greenbrier – Reduced position
  25. Halliburton
  26. Hecla Mining
  27. Hershey
  28. Ingredion
  29. JP Morgan
  30. Matson
  31. Microsoft – Reduced position
  32. MTN Group
  33. Navigant Consulting
  34. New Gold
  35. Nokia
  36. Nordic American Tanker
  37. Norfolk Southern
  38. Nucor – Reduced position
  39. Olin Corp
  40. PayPal
  41. Phillips 66
  42. Qualcomm
  43. Reaves Utility Income Fund – Reduced position
  44. Synaptics
  45. Ten Cent Holdings
  46. Travelers
  47. Twitter
  48. Viacom
  49. Wells Fargo
  50. Yum! Brands
  51. Zimmer Biomet Holdings

The Song Remains the Same

Tom Connolly’s Equity Market Forecast

for the upcoming week beginning April 4, 2016

With Market Questions and Answers

 

Summary Comments:

The market does not appear to be a bargain at this stage.  The current pricing implies growth that is greater than what is forecasted, as the market trades on a very low to negative interest rate environment.  Economic data in the United States does reflect a stabilizing environment with some growth potential, but the lack of a more robust expansion gives pause to the idea of investing greater levels of capital to the equity market.  One can chase the favorable dividend yields of equities vs fixed income, but that is a path with risk that seems to outweigh the reward at this point in time.  The discussion below attempts to highlight the strengths and weaknesses I see.

 

YTD Connolly portfolio gain as of April 1, 2016 equals        +4.40%

S&P 500 Index YTD gain as of April 1, 2016 equals              +1.41%

NASDAQ Index YTD loss as of April 1, 2016 equals              -1.85%

 

Portfolio composition as of April 1, 2016 is as follows:

  • Equities                  34.9%
  • Cash                        47.8%
  • Gold                         13.7%
  • Fixed Income          3.6%

 

Forecast for the week:   I think I should reprint my commentary from the prior weekly market assessment.  My sentiments remain the same (reminds me of the Album “the Song Remains the Same” by Led Zeppelin).  Yes, the market is more highly valued than I believe it should be.  It is not dramatically overpriced, but executing on any entry points at this time feels imprudent.  At the same time, I have no desire to further sell down my portfolio as I know the market can run higher from here.  We are not in nose bleed territory, at least not yet, but we are not in a place where true bargains are present either. 

In this environment I maintain an E-Mini short position, a healthy allocation to precious metals that is somewhat hedged with put options, and an array of strong dividend generating equities.  While I am frustrated, I continue to sit on the sidelines believing a better entry point to more aggressively allocate capital to equities is nearing.

On the flip side, I do see some evidence of economic bottoming and maybe, just maybe, some growth.  See the chart below.  This is not strong enough to justify the multiples the market is currently valued at, but if we continue to get improvement then maybe we will see that translate into upward revisions to future earnings and a reason to buy at the current market levels.  Presently, the S&P 500 earnings forecast for 2016 is only 2.23% above the 2015 earnings.  Not strong enough to justify the current S&P 500 PE multiple of 22.86X (forward multiple of 17.63X for earnings and 18.44X for cash flow).  Patience is often the right choice, but that is not easy for one who thrives on that adrenaline of urgency.

 Economic trends

 

For the upcoming week, I expect some uncertainty to begin to build as we move closer to the first quarter earnings’ announcements.   The warm winter should be a net positive for US centric companies, and for global businesses the stability of the dollar comparison quarter over quarter should remove the FX headwind.  The positive catalysts to earnings will be offset by the market turbulence of January and February, as well as the softness in economies throughout the world.  All in all, I see a less volatile market with no meaningful moves up or down absent an external catalyst.

 

Market Questions and Answers

What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?

The DJIA, NASDAQ and S&P are now in very over-bought territory.  The 12-week Relative Strength readings are 80 for the DJIA, 76 for the S&P, and 71 for the NASDAQ (RS in the 30s and below typically indicates an oversold market and hence a buying opportunity, while north of 60 typically indicates overbought conditions and a selling opportunity).  Reaching the current levels often provides a signal that the market will turn lower in the near future as profit taking actions are pursued by the professional investor community.

While I expect the market to be relatively sanguine this week it is important to note that we are near the prior highs.  Should the market turn lower as a result of some catalyst, the speed and degree of the decline could be breathtaking. I say this because prior support levels were breached during the January/February declines and the recent dramatic move higher could stall from exhaustion and fall back to prior lows.  Those lows would only bring the market back to fair value territory, so revisiting them sometime over the next few weeks or months is not out of the realm of possibility. 

The DJT is the one metric that has faltered of late.  It led the prior decline and the prior rise, and for the past two weeks it has not joined the other market indexes in the move higher.  While the other indexes are all moving higher, the DJT has declined from 8,077 on March 18th to 7,888 on April 1st.  You should keep an eye on the transports as it reflects the movement of goods/trade and people who provide services.  It is often the canary in the coal mine, so pay attention to the daily changes here. 

The DJU continues to be strong reflecting the safety of yield in a nervous world of Central Bank easing and Negative interest rates on foreign government debt.  The DJU exceeded its prior peak this week by closing at 671, a real reflection of the high dividend yield from Utilities versus the low interest rate returns from bonds.  Keep an eye on this index as it presently gives an indication of investor pursuit of safety rather than economic expansion (economic expansion would be evident if electric usage was accelerating thereby driving Utility profitability, and electricity consumption is not expanding at this point).

 

What is the current score on the Market tells metric?

The Market Tell indicator, which is a comparison of the market’s current cash flow and valuation metrics to its historic medians, closed the week at negative 58 as compared to last week’s reading of negative 41 (meaningfully lower than its high reading of +44.8 when the market made significant lows on February 12th).   When we have a high positive reading this is a strong buy signal and when we have a high negative reading it is a strong sell signal.  The Portfolio’s Cash flow multiple is 18.44X on expected 2016 full year results and 16.76X based on projected 2017 results.  These are relatively high readings of price to cash flow when compared to the historic medians of 16.8X and 14.8X, respectively.  Comparing current equity prices as the week closed on the 187 portfolio companies to their Discounted Cash Flow values indicates 72 companies were priced above their DCF value, which exceeds the historic average of 60 for the portfolio.  This supports an expected fall in the market as more companies have become overvalued.  I should note that at December 31, the number of companies in this category totaled 72 prior to the January decline.  The dollar spread between the Current Price and the Forward DCF price on the 187 portfolio continues to narrow and is now at $17.48, pulling back from the February high of $25.14.  This implies there is less potential price gains in this market.

 

What is the position of the net up down Vol/Issues? 

The week’s volume and issues did not provide any meaningful measure of confirmation or refutation of the week’s rise in the major equity indexes.  Volume was low during the week which surprised me given the expected quarter end portfolio activity of investment managers and pensions, but the Easter/School break timing may have taken many traders away from the market last week.  Having said this, on Friday it was curious to see that declining issues on the New York Stock Exchange of 1,610 exceed the advancing issues of 1,484 when the DJIA rose by 77 points.  This indicated that leadership on Friday was narrow as the broader market had more declining prices then rising prices even though the index went up.  Something to be concerned with.     

 

What are the daily point vs issues and point vs volume measures indicating up or down? 

The daily metrics of (1) index point moves vs volume in rising and falling issues and (2) index point moves vs rising and falling issues, were generally supportive of the daily point changes during the week.    

 

Where are the New Highs and Lows moving toward?

Confirmation of the positive trend continues to be evident as New Highs are on the rise indicating a possible new trend is being put in place.  Actual new highs for the past five days were the strongest yet this year at a cumulative net of 838 new highs (each days’ net of new highs over new lows for the day summed over the five day week).

 

How well are Market Tells correlating with Market trading internals?

The 5-day activity in volume and issues correlates very well with the major equity index changes.  Technically the market is supporting the buying and rising prices.  The fundamentals of the Market are indicating a contra-story.  For example, at this point in time one-third of the market is forecasting cash flows that are less than the prior year.  Additionally, the earning yield on the S&P 500 less the rate on the 10-year treasury equals 2.59%, which is a low return for the risk and volatility inherent in equities.   As noted earlier the Price Earnings ratio is high, as is the cash flow multiple for the current year and for the following year.  So we have a divergent set of conditions that will need to be resolved either through unanticipated earnings and cash flow growth or through a downward re-pricing of equities.  Time will tell.

 

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation (“CEDATEV”)?

The reading is +1 the same as last week.   Contributors are:

 Negative in the following areas:

Valuation

Duration

Trend

Positive in the following areas:

Calendar

Environment

Action

Emotion

Neutral in the following areas:

None

Other:

Bitcoin is at $418 and is showing some stability and higher valuation.  I continue to hold a position in Bitcoin as we move ever closer to digital currencies vs paper money and coinage.  Please note I also own PayPal given the success and penetration of the Venmo platform. 

Gold was volatile on the week and showed a weakening trend as it closed the week in the $1,223 per ounce area.  Miners were up and down, and did not perform very well.   I continue to hold a position within the precious metals complex but I have begun to hedge my gains to protect against any pullbacks. 

The Ten-year bond yield closed at 1.78%, down materially on the week as risk-on became more pronounced given the Fed’s dovish commentary.

The High Yield vs Investment Grade spread was very supportive of rising equity values over the first two weeks of March, but since March 15th it has showed some trend reversal tendencies as it has risen by 40 basis points.  The spread between HY and IG closed on Friday at 4.932%. The HY closing quote on Friday was 7.965% vs the Investment Grade close of 3.033%.  Keep an eye on developments in the oil patch for any re-emergence of HY concerns and potential spillover into the broader markets.

 

Have a great week!

 

Tom

Equity Portfolio Activity for the week ended April 1, 2016

Equity Portfolio as of April 1, 2016

 

Commentary:  I have been very passive these past couple of weeks.  Minimal buying and selling of equities fairly characterizes my activity.  Market fundamentals discourage me from new long positions, while technical indicators point to an overbought market with a slightly improving economic backdrop.  There are equities I want to buy now, but I feel I must wait for a better entry point, which becomes frustrating as the prices continue to advance higher.  Patience is my “Safe” word right now.

Good Luck and have a great week!

New Additions

  1. None

Increase in Holdings

  1. Endo – Added to holdings
  2. Twitter – Added to holdings

Complete Dispositions

  1. Fluor – Closed position
  2. Square – Closed position

Partial Decrease in Holdings

  1. None

 

Overall Equity Portfolio holdings

  1. Alamos Gold
  2. ASA
  3. Arm Holdings
  4. Alibaba
  5. BB&T Corp
  6. Brocade
  7. Brookfield Total Return
  8. Chevron
  9. Con Ed
  10. Costamare
  11. CISCO
  12. Corning
  13. Disney  
  14. Eastman Chemical
  15. Endo Int’l – Increased position
  16. Ericsson
  17. First Solar
  18. Fluor – Closed position
  19. Ford
  20. Frontline
  21. General Electric
  22. GLD
  23. Golar LNG
  24. GreatBatch
  25. Greenbrier
  26. Halliburton
  27. Hecla Mining
  28. Hershey
  29. Ingredion
  30. JP Morgan
  31. Matson
  32. Microsoft
  33. MTN Group
  34. Navigant Consulting
  35. New Gold
  36. Nokia
  37. Nordic American Tanker
  38. Norfolk Southern
  39. Nucor
  40. Olin Corp
  41. PayPal
  42. Phillips 66
  43. Qualcomm
  44. Reaves Utility Income Fund
  45. Square – Closed position
  46. Synaptics
  47. Ten Cent Holdings
  48. Travelers
  49. Twitter – Increased position
  50. Viacom
  51. Wells Fargo
  52. Yum! Brands
  53. Zimmer Biomet Holdings

First Quarter 2016 Investment Climate: The 187 Portfolio

The 187 Portfolio

 

In 2007, I transformed an individual equity tracking model I had built into a more dynamic market assessment tool that I call the 187 Portfolio.  The Portfolio consists of 187 companies that I selected based on their forecasted strong growth potential.  The industry representation is broad.  The market size is both large and small.  To give you an idea, the average market cap of the group is $38.4 billion.  Skewing this to the upside are $200 billion+ companies such as: Amazon, Apple, Facebook, General Electric, Google (Alphabet), Microsoft, Verizon, and Wells Fargo.  On the small cap-side the portfolio includes companies under $1 billion in market cap such as: Adtran, Blackbox, Dynamic Materials, Calgon Carbon, Greenbrier, Lattice Semiconductor, Pharmerica Corporation, Ultratech Inc, and a number of others.  The portfolio is designed to represent the overall market in support of my search for investment opportunities in individual companies, and it also serves as an indicator of the health of the overall market.   I should note that the portfolio does undergo changes as a result of companies being acquired or when a company falters in a manner that indicates it will not succeed in its business mission.  These events result in new additions to keep the Portfolio company count at the 187 level.

 

This work has presented wonderful investment choices for me, and it has invariably given me the signals of when the overall market is at turning points.  The discussion below will focus on the market signals presently being given by the 187 Portfolio.

 

  1. Is the market expensive today?  The 187 Portfolio indicates we have an expensive market.  It is not at peak levels of being overpriced, but the level of caution being flashed is very real.  Key metrics I look to from the model focus on cash flow, cash flow growth, operating margins, cash and debt levels on the balance sheet, dividends, EBITDA, enterprise value, and market value.  To put in context what one measure of historical comparison is telling us, consider the following table that compares the price of the Portfolio to the Cash Flow of the Portfolio for each March month end period from 2007 to today.  To be clear this compares March 2007 price and cash flow to March 2016, then March 2008 to March 2016, etc.   What it indicates is that cash flow growth and price increases are very well correlated through 2011, but have now reached that point where increases in price without further increases in cash flow would violate the historic correlation.  Forward cash flow growth projections are low, so we have a meaningful concern when looking to the future for higher prices.
price cash flow
March-16 % change % change
vs 2007 60.02% 74.79%
vs 2008 58.98% 60.68%
vs 2009 142.87% 99.58%
vs 2010 73.62% 66.53%
vs 2011 42.52% 34.30%
vs 2012 49.04% 18.97%
vs 2013 36.86% 16.04%
vs 2014 18.50% 10.76%
vs 2015 1.73% -2.11%

 

  1. Current Cash flow multiples and Discounted Cash flow values: The Current Price to 2016 Cash Flow projections yield multiples that are above the historic norm.  We presently have a cash flow multiple of 18.38X versus the historic average of 16.48X.  This higher multiple would be reasonable if the rate of cash flow growth projected into the future was higher than the norm. In that regard, looking back in time we find that the actual CAGR of cash flow for the portfolio since 2007 is 5.5%, and the current full year projection for the year 2016 is 4.74%, below the historic CAGR.  Of greater concern is that the March 2016 to March 2015 comparative cash flow projections indicate a contraction in cash flow of a negative 2.11%. Future price increases given the current Price to Cash Flow multiple is doubtful absent some accelerated growth that is presently not anticipated.   In regard to Discounted Cash Flows, each company is assessed based on its current price and the computed value of a share of its stock based on its current and projected cash flow change over time, discounted back to today.  For the portfolio there will always be equities that are fairly priced, under-priced, and over-priced.  Historically, the number of companies within the Portfolio that trade in the market at a price above their DCF value is 60.  Presently we are at 72 companies trading above their DCF value.  When we are materially above 60 the market has subsequently sold off.  The high CP>DCF count was 85 on January 17, 2014.  The low count was 22 on September 30, 2011.  For reference purposes, the January 2014 excessive DCF number led to over a 1,000 point decline in the DJIA over the next 17 days, while the September 30, 2011 low was followed by a 1,600 point rally in the DJIA over the next month.

 

  1. Average cash flow per share forecast 2016 versus 2017:  The market projects average cash flow per share for 2016 of $3.89, whereas the cash flow per share for 2017 is projected at $4.28.  The spread of $.39 is the lowest projected annual dollar growth over the past five years, and given the higher denominator compared to prior years, the lowest percentage growth since 2009.

 

  1. Enterprise Value divided by EBITDA and Debt levels:  This measure provides an indication of the companies (markets) ability to provide sufficient liquidity to support the needs of the business, particularly when high leverage or debt is present.  Currently the 187 Portfolio has a 12.25X EBITDA to EV ratio (meaning the Enterprise Value is 12.25 times the size of EBITDA).  This is above the historic average of 10.78X.  Why do we have this higher multiple?  Consider that the change in debt for the Portfolio from 2009 reveals a 45% increase in debt.  That growth in debt would be acceptable given the growth in cash flow over this period, except for the fact that actual cash on the balance sheet has declined by 10.57%.  I interpret this mix of information to be reflective of the C-Suite decisions to utilize cash and leverage to facilitate high Stock Buy-backs and Dividend increases, driving up stock prices versus a growth agenda that would increase EBITDA in a manner that would drive down the EV/EBITDA ratio.  Short term stock price decisions vs long-term reinvestment choices often come home to roost in a less than favorable way over time.

 

  1. Dividends:  There is an argument present today that even with the sense of our current market being expensive, it should be expensive given the alternative investment choices in this very low to negative interest rate environment.  It is an argument that carries meaningful weight.  However, given the breadth of the economic, market and portfolio discussion above, a discussion that highlights many data points of valuation concern, the perceived investment for dividend argument over fixed income as a justification for an expensive stock market seems to lose some strength when one considers the chart below.  I do not see any evidence of a meaningful change in the dynamics to support a higher level of equity valuation vs fixed income.  As noted above the cash flows and growth rates are modest, and the interest return over dividend return noted below remains range bound between 1.09% and 1.83%.  In balancing risk vs reward, the dividend argument is not strong enough for me to place greater value on equity investments.
2016 2015 2014 2013 2012
Dividend Rate 2.38% 2.13% 2.31% 2.33% 2.09%
10 year Treasuries 1.88% 1.96% 2.74% 1.94% 2.32%
Fed Funds Rate 0.36% 0.11% 0.08% 0.16% 0.15%
Interest Yield Gap -1.14% -1.09% -1.83% -1.24% -1.83%

First Quarter 2016 Investment Climate: The Market

The Market

Crossroads present themselves here as well.   The trend of the market indexes and the market internals appear to be in a pattern we have not seen in years.  Since March of 2009 we have been in an unrelenting uptrend.   Corrections have occurred and they have generally been steep and short.  But, if we look out over the past two years of flattish behavior, and the rolling over pattern that began with the last weekly closing high in May of 2015, the market is signaling something new.  Look at the DJIA chart below, a weekly chart going back to 2005.  The foot to the pedal relentless march higher fueled from Quantitative easing introduced to a dramatically oversold condition in March 2009 has faded and we now find the current gas tank reading is very close to empty, as we search for the next gas station amidst the many choices presented by the Crossroads. Given the US economic data discussed above, we may find we are walking and pushing with sheer sweat and muscle a market that needs a spark to turn over the engine one more time.  We need more than Central Bank money creation, currency debasing and interest rate destruction to support the fundamental economic needs and opportunities our world offers.

DJIA

 

  1. Price Earnings: The measure of value represented by the Price Earnings ratio indicates an overvalued market.  Often this is the market’s way of looking forward to accelerating growth, pricing in the optimism of higher profits and revenues from expanding consumption and productivity in the future.  With worldwide economic growth forecasted at sub-3%, the pricing in of optimism may be overdone.  Presently the S&P 500 PE ratio is 22.46X.  The median since 2005 is 18.77X.  The current PE is higher than any point since 2010, and has risen from a bottom on November 25, 2011 of 13.31X.  I find it hard to justify the price in the PE formula and can only conclude at this juncture that price has to come down.  Now, there are some who argue that the market should trade expensively in the current low interest to NIRP environment.  I have looked at this and while some aspects of the argument make sense, in the whole I do not find it credible when all of the pieces are put together.  I will delve a bit deeper on this topic in the subsequent discussion of the 187 portfolio.  One last point to make here which is an important fact:  The rise in the S&P index is lagging the growth in the PE ratio.  This effectively means earnings are contracting when compared to price.  A huge warning sign.
  2. Resistance:  The S&P, DJIA, DJ Transports and NASDAQ are all hitting upper resistance points from the bottom.  I utilize moving averages for each index where I calculate the average, and then create an upward and lower average that surrounds the actual average.  These lower and upper bands have shown to be very reliable bounce points.  Over the past seven years when the indexes have pulled back from their upward advance, invariably the lower bands have proven to be the point where the decline ended and the resumption of the advance continued.  Presently, the opposite is happening.  The January to mid-February trend to the downside of the indexes has just seen a dramatic reversal.  Guess where the indexes now sit?  They are reaching the upward moving average band from below.  If we apply the historic experience of an advancing trend continuing once the lower band was reached as a support level, then the market is now signaling the arrival of an interim top in a downward trending market.  I expect the declining market trend to be confirmed when the indexes bounce off of the upper resistance band, resulting in a falling market in the weeks ahead.
  3. Relative Strength:  The RS indicators are indicating an overbought condition.  The up and down point moves over the past twelve weeks are exceptionally high compared to history.  Individually, they would indicate extremes but combined they have been neutral over the past four or so weeks.  Presently, the downward point measure is shedding the declines from January and this is resulting in a heavier weight on the seesaw from upward points.  Typically, the market will seek to bring the pendulum back to equilibrium, and this foretells a decline in the coming weeks.
  4. Breadth:  The comparison of the S&P and the NASDAQ to the DJIA indicates a narrowing of breadth.  The NASDAQ is presently at 27.25% of the DJIA, down from 29.46% back in September 2015.   The S&P is at a similar point.  Additionally, the advance decline lines of issues have been deteriorating over the past year.  The divergence of the point moves in the indexes to the number of issues advancing vs declining shows a contraction of participation and a narrowing of overall rising companies vs declining companies.  The absence of broad participation speaks loudly to the underlying weakness of the market internals.
  5. New highs and lows:  The net here has been in a declining trend for quite some time.  Presently the last week’s reported net new highs over new lows totaled 139 for the NYSE and 5 for the NASDAQ.  This compares to the last peak of net new highs over lows from June 2014 of 523 for the NYSE and 188 for NASDAQ.  Again, lack of participation by the broader market is telling.
  6. Current Interest Yield Gap:  The CIYG favors stocks over bonds.  In regard to portfolio allocation, the dividend returns from equities is very favorable as compared to the interest coupon from bonds.  The gap today is 1.05% (bonds over equities), which is very low based on historic comparisons.  The median gap over the past eleven years is 2.64%.  Of course, the return of principle profile for equites vs bonds gives a greater risk profile to equities, which indicates that a higher dividend return is needed as compared to interest rates to offset the return of principle exposure.  Should the interest rate environment change and the tightening of credit appear, then the spread will widen and equities will likely face price pressure as portfolio allocations move to fixed income.