S&P500 is Rolling Over: When Will it Stop?

Thursday, October 25th, 2012

by Don Vialoux, Tech Talk, EquityClock.com

Upcoming US Events for Today:

1. Weekly Jobless Claims will be released at 8:30am. The market expects Initial Claims to show 372K versus 388K previous. Continuing Claims will be released at 3237K versus 3252K previous.
2. Durable Orders for September will be released at 8:30am. The market expects a month-over-month gain of 7.0% versus a decline of 13.2% previous. Excluding Transportation, the expectation is a gain of 1.0% versus a decline of 1.6% previous.
3. Pending Home Sales for September will be released at 10:00am. The market expects a month-over month increase of 2.5% versus a decline of 2.6% previous.
4. Kansas City Fed Manufacturing Index for October will be released at 11:00am. The market expects 4 versus 2 previous.

Upcoming International Events for Today:

1. Great Britain Gross Domestic Product for the Third Quarter will be released at 4:30am EST. The market expects a year-over-year decline of 0.4% versus a decline of 0.5% previous.

The Markets
Markets struggled on Wednesday, finishing slightly in negative territory as weak PMI numbers out of Europe and continued earnings struggles have investors questioning future growth. Manufacturing and Service PMIs in Europe are indicated to have pushed further into contractionary territory for the month of October, missing estimates calling for a slight improvement over past results. PMI services in Germany, which had previously indicated expansion with a reading above 50, fell below this median line, leaving investors to doubt that the one bright spot in Europe might also be succumbing to the recessionary pressures in the region. Manufacturing seasonally picks up in November through to May, but signs of bottoming in recent European economic numbers have yet to be realized. Meanwhile, in the US, investors remained focused on earnings. The theme of the season appears to be “60-40”: 60% of companies are beating on earnings due to cost reduction initiatives and only 40% are beating on revenues as slowing growth around the world takes a bite out of top line results. The impact of the US dollar has also been cited as reason for lower revenues due to the rise in the currency that took place in July and August, creating an unfavorable exchange rate for international companies. However, the US Dollar index has declined substantially since the end of August, pushing the currency back to levels last seen in the Spring. Depreciation in the US Dollar should act as a tail-wind for revenues into the fourth quarter, typically the period when substantial revenues are generated, particularly for consumer companies. The US Dollar Index seasonally trades flat to positive in October and November, followed by negative tendencies in the month of December. Today is the busiest day of earnings season thus far with 309 companies reporting, including Aetna, Altria, Biogen, Cenovus Energy, Colgate-Palmolive, Conoco-Phillips, Dow Chemical, Goldcorp, Hershey, International Paper, Potash, Procter & Gamble, Pulte Homes, Raytheon, Royal Caribbean Cruises, Occidental Petroleum, National-Oilwell, Celgene, Amazon.com, Apple Inc, Consol Energy, McKesson, Noble Energy, Simon Property Group, Sprint, Starwood Hotels, Cabot Oil, Chubb Corp, Eastman Chemical, and Hewlett-Packard.

Equity markets continue to realize technical damage as the bears take control of the price action. Momentum indicators, such as RSI and MACD, continue to trend negative. Levels of support, presented by major moving averages and horizontal levels of significance, continue to be broken. Breadth continues to decline. Evidence is overwhelming that the market is rolling over and it is not a matter of how far the markets fall, but how long will the selling last. Consensus amongst analysts is that an area just above the 200-day moving average for the S&P 500 will provide the first point of support for this market. However, support under this market still remains quite plentiful, so it would be pure speculation over which point holds. The more important question is “how long will the selling last?” Generally, at this point in the third quarter earnings season, a market pullback is normal as earnings are digested. The majority of companies will have reported by the end of next week, suggesting that the earnings influenced weakness may conclude by mid to late next week, potentially kicking off the period of seasonal strength for the markets that runs from through to May. Also, the typical factor for end of October gains during the presidential election year prior to voting day may not occur. Usually investors have a good idea at this point in time, after the debates have concluded, who the president will become, introducing clarity to equity markets. However, the spread between the candidates is still extremely tight. Mitt Romney was indicated to be 1 percentage point ahead of Barack Obama according to Wednesday’s Reuters/Ipsos daily tracking poll. Uncertainty prior to the election could keep investors on the sidelines in the short-term.

Despite ongoing equity market weakness, reason to be optimistic of future strength remains. US Treasuries, the long-used risk-off trade, have barely moved amidst significant weakness in equity markets over the past month. Yields on the 10-year note still remain around the 200-day moving average, suggesting that demand for these safe haven assets has not re-emerged to the detriment of stocks. A break of the 200-day moving average line for US treasuries could coincide with the next leg higher for equities as funds flow from bonds into stocks. As well, the US Dollar, another risk-off trade, has yet to show strength above the early October highs. The US Dollar Index continues to show signs of trending lower, trading below its 50-day moving average. A breakdown in the US Dollar Index below support at 78.60 would likely act as a bullish catalyst for risk assets, mainly stocks and commodities. Another positive for risk assets is the fact that inflation expectations continue to trend higher. Using the ratio of the TIPS Bond Fund (TIP) versus the 7 –10 year Treasury Bond Fund (IEF) as a benchmark for inflation expectations, the intermediate trend remains firmly higher from the summer lows. Stocks and commodities have historically performed well during inflationary periods, typically induced by past quantitative easing programs.

Sentiment on Wednesday, as gauged by the put-call ratio, ended bullish at 0.91.

S&P 500 Index

Chart Courtesy of StockCharts.com

TSE Composite

Chart Courtesy of StockCharts.com

Horizons Seasonal Rotation ETF (TSX:HAC)

• Closing Market Value: $12.45 (down 0.48%)
• Closing NAV/Unit: $12.43 (down 0.42%)

Performance*

* performance calculated on Closing NAV/Unit as provided by custodian

Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.

Tags: Bonds, ETF, ETFs, TechTalk, Us Treasuries
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David Rosenberg: “What is Wrong With This Market?”

Thursday, October 25th, 2012

From David Rosenberg of Gluskin Sheff

My Evolving Macro And Market Thots

What is wrong with this market? The S&P 500, instead of grinding higher in the aftermath of QE3 actually hit its peak for the year the day after the policy announcement. Go figure. Maybe economic reality finally caught up with Mr. Market (there is a very fine line between “‘resiliency” and “denial” — and keep in mind that the S&P 500 is still up 14% in a year in which profits are now contracting, not just slowing down).

And the cyclicals and Financials have lagged the defensive sectors.

I looked at all the prior major non-conventional easing measures in the past four years: QE1, QE2, Operation Twist, and the ECB-led Long-term Refinancing Operation which a year ago was a really big deal in unleashing a massive global risk-on trade.

On average, six weeks hence, the S&P 500 was up more than 9% after the policy announcement. It was all so novel! Tech on average was up over 11%, industrials were up 12%… ditto for Consumer Discretionary and Materials. The cyclicals flew off the shelves.

But this time around. either Mr. Market is jaded or the laws of diminishing returns are setting in.

Six weeks after the unveiling of QE3, the market is down 2%. This hasn’t happened before. Every economic-sensitive sector is in the red, and even Financials — the one sector that should benefit from all the “sucking at the Fed teat” — have made no money for anybody! Of course, there are the compressed net interest margins to consider.

The bottom line is that since that famous September 13th FOMC meeting that had the bulls going hog wild, the only equity sectors that are in the plus column are …

• Utilities: +1.5%
• Health Care: +2.4%
• And while Consumer Staples are down fractionally, they have outperformed the broad market by 120 basis points

In other words, as aggressive as the Fed has become, maybe, just maybe, Mr Market is starting to focus on the patient rather than the prescription.

The problem is that at the highs, the market had become overbought and right after that September 13th QE3 announcement, the CFTC (Commodity Futures Trading Commission) data showed the hedge funds had already jumped in and the buying power became quickly exhausted. Sentiment surveys and the low levels of the VIX index flashed a certain level of complacency. On each of these post-QE rallies, momentum had become increasingly diminished, and it has been no different this time around. And the bond market has consistently refused to buy into the economic reacceleration viewpoint dominated by the equity bulls. A cursory look at the charts suggests that a near-term top has been turned in and the popular view of a rally into year-end is beginning to look a bit discredited here.

S&P 500 revenues are set to decline on a YoY basis for the first time in over three years. Here we are, one-fifth into earnings season, and less than 40% have managed to beat their sales estimates – we have not seen a number this low since the first quarter of 2009 when U.S. GDP contracted at an epic 5.3% annual rate (and 20 percentage points below the historical average)! I guess this does matter for the stock market, after all, despite all the money printing out of the Fed which merely debases wealth instead of creating it. With margins coming off cycle highs and all the fat already being cut out of the corporate cost structure, faltering sales can be expected to exert an outsized influence over profits in coming quarters. Be prepared for more downward revisions in the EPS outlook, which means be diversified, defensive and dividend-driven.

Of note for pro-cyclical enthusiasts, the Asian stock market, a pro-growth bellwether, has now turned in three losing sessions in a row – a 0.4% drop today with two declines for every advancer. The economic-sensitive Korean Kospi index led the decline with a 0.8% setback and China was down 0.9% in its worst day in four weeks. Equity markets are down through most of the planet today (Japan an exception) with economic and political concerns re-ignited in Europe, a spotty earnings cycle and, of course, what the polls may show with President Obama “winning on points” according to the experts with regards to last nights debate. Though it was interesting to see the incumbent sound more like a challenger… “Attacking me is not an agenda” I thought was one of the better lines of the night; I realize that people need sound-bites and the President, in classic Chicago-style-politics sarcastic for sure delivered some zingers, but Romney was most effective, I thought, and stayed on message, as non-sound-bitey as it may have been, that, sorry, Bin Laden may indeed be dead but Al Qaeda is not and is staging a comeback…  see the op-ed on this file by Jack Keane, former Vice Chief of Staff of the U.S. Army, on page A17 of the WSJ.

To be sure, Obama is a brilliant debater and ostensibly king of the one-liner, but Romney did come off as a credible leader and keep in mind that no matter the “spin”, the president had a 10-point lead in the polls as recently as July and all signs still suggest a neck-and-neck race. As an aside, it’s not just tax policy, energy policy and foreign policy that are at stake in the coming election, but Fed policy will likely be affected as well — for more on this file, see On Fed’s Horizon; Nov. 6 Looks Large on page B1 of the NYT.

The euro is softening now on the news that Moody’s cut the credit ratings of five Spanish regions and French business confidence tumbled to its lowest level in over three years in October (lnsee index down to 85 from 90, the lowest reading since August 2009). As if to add insult to injury, Spanish GDP contracted 0.4% in Q3, matching the Q2 decline (though better than what was generally expected) and the fifth straight shrinkage.

On a day when there was little in the way of data-flow, what was key yesterday was what Caterpillar had to say about the global economic outlook and the picture painted was no Picasso — announcing that the global headwinds are even more acute than previously thought, citing that end-user demand “is not growing as fast as we were expecting it would” (full-year sales seen now at $66 billion from $67.64 billion and 2013 revenues now seen -5% instead of +5%). Texas Instruments reported that its quarterly revenue dropped 2.3% as demand for its chips receded and the CFO (Kevin March) stated “across the board, we’re seeing customers being extremely cautious, very careful about the level of inventory that they hold so giving us very low levels of visibility as to what they’ll want to order for the quarter“. Now does that sound like escape-velocity to you? Freeport-McMoRan missed its EPS target for the first time in 17 quarters … an inflection point, perhaps? Dupont missed too this morning (cutting jobs as well) and what was that Philips Electronics said yesterday? That “the economy in the U.S. is at the moment moving a little bit sideways”. Yikes… that means stagnation. No growth. Microsoft doesn’t get the attention it once had with the likes of Apple and Google now the darlings of the tech world, but the bellwether is now down 10% in the past month (stock price, that is) and as such is in official correction terrain. And didn’t we near from Canadian National Railway (CNR) yesterday say that it is expecting a “challenging end to the year‘ even though it delivered a Q3 results that fractionally beat estimates?

But at least Yahoo surprised to the high side — a rarity so far in the fairly bleak earnings reporting season (something like 8% of the S&P 500 companies report today). May as well find those needles in the haystack.

Also have a glimpse at the article on page B1 of today’s NYT titled Dwindling Demand: China’s Slowing Economy Puts Pressure on American Exporters. Fiscal cliff notwithstanding, the really big risk is a negative export shock about to hit the U.S. economy…  did anyone notice that Q3 industrial production actually contracted, albeit fractionally, for the first time since the depths of the Great Recession over three years ago? And if you have become a bull over Europe, notwithstanding all the ECB support in the world, the problem of massive excessive indebtedness has not gone away instead, it has gotten worse. See Despite Push for Austerity, European Debt Has Soared on page 138 of the NYT.

If deflation was not a primary theme, then we likely would not have seen gold break below its 50-day moving average this morning, with the overall commodity complex moving in the same direction (the oil price has declined now for four days running). Copper and gold (the red and yellow metals) have now traded down to six-week lows! Ditto for platinum. Now that is deflationary — and confirmed by the behaviour in the bond market U.S. Treasuries (and German Bunds) are back in rally-mode, even in the face of this week’s $99 billion new- issue calendar in the government bond market and it is nice to see how the 200-day moving average on the 10-year 1-note proved to be solid support for the fifth time this year!

Again, all these market moves are diametrically opposed to what we had experienced after the prior QE moves … call it life at the zero-bound. The only difference is that this time around, the market realizes that the Fed is pushing on a string. Perhaps in a classic sign of “unintended consequences”, the Fed’s actions are now doing more to hurt the Financials than help them — see Low Rates Pummel Banks on the front page of today’s WSJ. Financial industry profit levels are sagging to their lowest level in three years on the back of increasingly squeezed Fed-induced net interest margins. Indeed, margins are down now for five quarters in a row and at 31.2% to their tightest levels since the second quarter of 2009 (when they needed a government bailout).

Yes, yes, housing and autos have both enjoyed good years, but don’t confuse a cyclical upturn with a level shift — and I sense we are in the latter in each sector. Single-family starts now exceed sales by more than 60% and only 30% of the sales are by first-time buyers. That does not tell me housing is in some durable uptrend, and the reality is that after over-cutting, the builders have now caught up with demand. And after two years in which uber frugality took the stock of U.S. motor vehicles down for two years in a row, there was indeed some good pent-up demand (the fact that the median age of the existing stock is over 11 years is immaterial because cars are being built to last longer today) but the buying intentions surveys suggest that the peak has been turned in. The question is that if I am correct in the assertion that the mini housing and auto cycle has run its course, and all this could produce was economic growth of 1.5% for this year, then what picks up the mantle and prompts anything better than that meagre GDP trend (which is one-third what is typical for an economy supposedly heading into year-four of an expansion). Indeed, you know that the housing rebound is on a short leash when people aren’t shopping for furniture or home appliances any longer—just have a look at Appliances Hit Slow Cycle on page 35 of today’s WSJ.

Tags: Rosie
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A New Low for China Bashing (Roach)

Thursday, October 25th, 2012

by Stephen Roach, Yale University, via Project Syndicate

October 23, 2012

NEW HAVEN – As America’s election season nears its finish, the debate seems to have come unhinged. Nowhere is that more evident than in the fixation on China – singled out by both President Barack Obama and his Republican challenger, Mitt Romney, as a major source of pressure bearing down on American workers and their families. Get tough with China, both stressed in the presidential debates, and the pain will ease.

Nothing could be further from the truth. Consider the following charges:

Currency manipulation. Since China reformed its exchange-rate regime in July 2005, the renminbi has risen 32% relative to the dollar and about 30% in inflation-adjusted terms against a broad basket of currencies. These are hardly trivial amounts, and more renminbi appreciation can be expected in the years to come.

Unlike Japan, which was pressured by the West into a large yen revaluation in 1985 (the “Plaza Accord”), the Chinese have opted to move gradually and deliberately. American officials call this “manipulation,” arguing that market forces would have resulted in a sharper renminbi appreciation than has occurred. Fixated on stability – a concept alien to US politicians and policymakers – the Chinese prefer, instead, to play a more active role in managing the adjustment of their currency. I call that prudence – perhaps even wisdom. Two lost decades later, the guinea pig, Japan, might have a view on which approach works best.

Keep Reading This Article

Copyright © Project Syndicate

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3 Investment Strategies for the New World

Thursday, October 25th, 2012

by Russ Koesterich, iShares

In a previous blog I discussed the many ways in which the investment climate has changed,and why we’re unlikely to revert back to a more familiar environment anytime soon.

Given the magnitude and scope of these changes, it is natural that many investors have decided to deal with the uncertainty by simply increasing their allocation to cash. While this may make sense from a tactical perspective, a permanently high cash balance may not be a good long-term solution. With cash yields at zero there are alternatives which increase the potential for yield for investors willing to assume additional risk. Here are three strategies for investors looking to adapt to the new landscape.

1. Cast a wider net
In a low-yield environment, casting a wider net – both geographically and by asset class – may lead to other sources of potential income. Investors looking for higher yields and willing to tolerate additional volatility may consider the judicious use of equity income as a substitute for fixed income. Equity yields currently compare favorably with bonds, and certainly much more favorably than cash. In many parts of the world – Europe, south-east Asia, and select emerging markets – there is still potential to see a 3.5, 4, or even 5% yield at a reasonable valuation with varying degrees of risk.

2. Manage volatility
The global deleveraging is still in its early stages. To the extent this process is contributing to the rise in equity volatility, we may have to contend with turbulent equity markets for a while. That said, abandoning equities entirely is rarely a good idea, as the asset class has historically produced higher returns – both on a nominal and an inflation-adjusted basis – than bonds. An alternative strategy is to consider the use of non-traditional portfolio construction techniques and instruments. In particular, there is strong evidence that minimum volatility portfolios can potentially help investors cushion their portfolios during periods of heightened turbulence, but more importantly can help improve risk adjusted returns over the long-term.

3. Consider commodities
While I do not view inflation as a near-term threat, central bank balance sheets have exploded and there is lingering uncertainty over the US fiscal position; both raise the long-term risk of a potentially significant dollar decline and/or higher inflation. In addition to equities, investors might also consider allocating a small portion of their portfolios to commodities and gold. Physical assets behave differently than paper assets like stocks and bonds. Gold, in particular, has historically been used as a long-term hedge against a loss in purchasing power. For investors with a moderate risk-tolerance that are concerned about inflation, a small, diversified commodity allocation plus another small allocation to gold is reasonable.

In the end, an investor’s asset allocation will be as much a function of their investment goals and risk appetite as the investment landscape. But in an environment in which the macro-conditions are very different from the past twenty-five years, all investors should be re-visiting their investment process and tool-kit. These are different times; most investors will benefit from adjusting their approach.

Source: Bloomberg

Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog. You can find more of his posts here.

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Bonds and bond funds will decrease in value as interest rates rise. Bond funds are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies.

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume

Minimum volatility funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.

Gold and other precious metal prices may be highly volatile. The production and sale of precious metals by governments, central banks or other larger holders can be affected by various economic, financial, social and political factors, which may be unpredictable and may have a significant impact on the supply and prices of precious metals.

Tags: Koesterich
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The Advisor’s Social Neighborhood (Infographic)

Thursday, October 25th, 2012

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Based on Real Math The S&P 500 Is Fairly Valued

Thursday, October 25th, 2012

by Chuck Carnevale, F.A.S.T. Graphs

As investors, we do not believe in forecasting stock markets or stock prices on individual stocks. Instead, we approach investing as the process of calculating intrinsic value based on fundamentals. To us, the most important fundamental to be considered when evaluating the True Worth™ of a market or a common stock is earnings. Therefore, it’s important that the reader understands that this article is offered as a mathematical calculation of what the S&P 500 is actually worth based on earnings. The reason we believe this to be important is because we also believe that any deviations from fair value will ultimately self-correct.

As we will soon illustrate, in the short run the stock market has a penchant for grossly mispricing common stocks and broad indices. When this is occurring, it is extremely valuable and important for investors to be able to recognize extreme and/or erroneous valuations when they manifest. It is also our contention that the calculation of fair valuation is both practical and achievable. In contrast, we further believe that attempting to forecast short-term market or price movements to be an exercise in futility. When irrational behavior is rampant, there is no logic that can be applied.

Our point is, making investment decisions based on valuation is a sound exercise that will bear fruit long term. As already stated, in the shorter run prices can go beyond fair value or below it. But, inevitably stock prices will seek intrinsic values. Therefore, we believe that intrinsic value is something that can be trusted, whereas stock price volatility cannot. Admittedly, this is not as easy as we may be making it appear. The trick lies in forecasting future earnings as accurately as possible. The better you can do that, the more accurate your long-term forecast will be. But, once again, we contend that forecasting earnings can be done more accurately than attempting to forecast short-term price movement. On the other hand, this is easier to do on an individual company (business), than it is on a broad index like the S&P 500.

Historically Normal Valuations

When writing articles such as this, many authors tend to gravitate towards statistical references. And, although there can be value found through statistical analysis, it’s also very easy to draw erroneous conclusions. With that said, there is a preponderance of historical data, and calculations based on that data, that the historical normal PE ratio for the S&P 500 is 15. However, even more importantly, we believe that there is a rational mathematical explanation for why a PE of 15 represents the proper average valuation for most companies, and therefore, an index like the S&P 500.

A detailed explanation of the mathematical validity of the PE equals 15 thesis is beyond the scope of this article. However, a brief explanation of the underlying principles should suffice. The normal PE of 15 is based on the reality that a stream of income generated from an investment is worth more than one times earnings. This is true even if the future income stream does not grow. In other words, if we assume, for example, an interest rate of 8.5% on a bond (of course bond yields are much lower than that today), we would discover that the bond is trading at approximately 12 times interest. Since the future income stream on a bond is fixed, it only stands to reason that a growing income stream, such as found on a stock, should also command a multiple greater than one, adjusted for risk.

That number has historically hovered around a PE of 15, because this represents an earnings yield of 6%-7%. This number is very close to the long-term historical returns that stocks have delivered on average. Admittedly, we have not provided significant proof of our statement based on what is written above. Instead, we are simply offering some hints as to how the normal PE of 15 can be justified. Put another way, there is a lot of research that suggests that the normal PE ratio for the S&P 500 over the past 100-plus years is 15. Additionally, there is further research that indicates that the normal PE ratio for the S&P 500 over the past 20 years has been closer to 20 (19.3 on our graph below). Our analysis, and a quick glance at the earnings and price correlated graph below, indicates that this higher than normal PE over the past 20 years can be mostly attributed to excessive overvaluation.

The S&P 500 via F.A.S.T. Graphs™

When looked at through the lens of our F.A.S.T. Graphs™ research tool, we can test theory and see how it applies in the real world. The following earnings and price correlated graph of the S&P 500 since calendar year 1994 tells some interesting stories. Perhaps the most interesting story is how the chart depicts two calculated PE ratios that equal the 20-year historical normal PE of approximately 20 (19.3), and the longer-term normal PE ratio of 15. In the first case, the PE of 20 (blue line with asterisks) was determined as the computer calculated the trimmed mean (outlier highs and lows trimmed to eliminate skewing) PE ratio for that time period. In the second case, the PE of 15 was determined by applying a widely-accepted formula for valuing businesses to the EPS growth rate of 7.5% for the S&P 500 since 1994.

The important takeaway from reviewing the earnings and price correlated graph is the visual depiction of how statistics can mislead. Clearly, the black monthly closing stock price line often deviated significantly above and below the trimmed mean PE ratio of 20. Therefore, even though it is statistically accurate to state that the normal PE over this time frame was 20, a quick visual shows how often that was not true. As previously stated, we believe that the graph vividly illustrates the meaning of the phrase “irrational exuberance.” On the other hand, we believe the graph further vividly illustrates how the black monthly closing stock price line continuously attempted a reversion to the mean towards a historically significant normal PE of 15. The reader should note that although all data is plotted, when we draw a graph of 20 years, we only type in every other year’s data because of space restraints (Note the asterisks by the years at the top of the graph).

Conclusions

In conclusion, there continues to be a lot of opinion and speculation regarding whether the S&P 500, or the stock market, or stock prices in general are overvalued or not. From the perspective of earnings justified valuations as depicted in the graph above, at 14.1 times earnings, it is arguable that the S&P 500 is slightly undervalued at these levels. Moreover, taken directly from their website, the current forecast for operating earnings of the S&P 500 by Standard & Poor’s Corp. is $101.33. If this forecast is accurate, this would imply a year-end fair value for the S&P 500 of approximately 1519.40.

Mathematically, it would indicate that the S&P 500 has approximately another 7.52% upside by year-end. Once again, this is not a prediction, instead this is a mathematical calculation based on applying a normal PE ratio of 15 to the current earnings expectations of the S&P 500. It is our intention to provide an updated F.A.S.T. Graphs™ on the S&P 500 periodically. If forecasts change, then so will the anticipated valuation expectations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

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SIA Stock Bulletin: Norfolk Southern Corp. (NSC) (October 25, 2012)

Thursday, October 25th, 2012

SIA Charts Daily Stock Report (siacharts.com)

Norfolk Southern Corp (NSC) – After falling out of the Favored zone of the SIAS&P 100 Report back in February 2012, Norfolk Southern (NSC) has dropped over 15% and is now down towards the bottom of the report. Resistance is at $66.89 and again at $76.84. Support is now at $58.23 and again at $51.71.

Green – Favoured Zone
Yellow – Neutral Zone
Red – Out of Favour Zone

Important Disclaimer

SIACharts.com specifically represents that it does not give investment advice or advocate the purchase or sale of any security or investment. None of the information contained in this website or document constitutes an offer to sell or the solicitation of an offer to buy any security or other investment or an offer to provide investment services of any kind. Neither SIACharts.com (FundCharts Inc.) nor its third party content providers shall be liable for any errors, inaccuracies or delays in content, or for any actions taken in reliance thereon.

Copyright © siacharts.com

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“Voluntary Exile” (Smead)

Thursday, October 25th, 2012

The Bible is full of stories of God’s people living in exile on their own volition. A famine occurred in the land of “milk and honey”, so the Hebrews moved to Egypt at the time of Joseph. The father-in-law, brother-in-law and husband of Ruth left Israel to live among the Moabites during a famine. Mordecai and Esther lived in Babylon among the Persians, even though God called his people to rebuild Jerusalem.

We at Smead Capital Management (SCM) believe that institutional and individual investors have moved their asset allocation away from large cap US stocks. Institutions are in exile in private equity, hedge funds and all things commodity and BRIC-trade related. Individuals are living in bond land and the rest of their liquid assets are residing in wide asset allocation through funds and ETFs.

Why did the Hebrew people get into so much trouble? They didn’t rely on God’s promise to take care of them even in famine. The Israelites stayed in Egypt long after the famine ended in Israel and ended up slaves to Pharaoh. Ruth’s male relatives dropped dead among the Moabites, stranding their families. Mordecai allowed his adopted daughter to sleep with the King. She became Queen and used her leverage to keep Haman from slaughtering all the Jewish people.

A famine occurred in the US stock market from March 10, 2000 to March 9, 2009. It was teed up by the 1990′s tech stock and large-cap growth stock boom. This triggered a movement out of long-only U.S. large-cap equities. According to the NACUBO studies done in 2010 and 2002, the pool of endowment funds sampled had only 15% in U.S. Equities on a dollar-weighted basis in 2010 vs. 36.7% eight years earlier.

In the aftermath of two 40-plus percent US stock market declines, investors exiled themselves voluntarily. We believe they lost faith in the best performing liquid asset class because they don’t think the ups and downs are worth the historically-superior return. Stocks have recovered nicely, while individuals loaded the truck with bond funds. According to the Lipper organization, US mutual fund investors have net-liquidated US large-cap equity mutual funds for 40 consecutive months. Institutions loaded up on illiquid private equity investments and what we believe are super-risky commodity/BRIC-trade related investments after 10 years of red-hot performance. Those returns were high both historically and compared to US large cap equity indices. Again referring back to the NACUBO studies, endowment funds increased their participation in alternative strategies from less than 20% in 2002 to 52% in 2010 on a dollar-weighted basis.

Why did the Hebrews stay in exile? They got comfortable with the early years in exile, but the decline in their circumstances was subtle and incremental. We like to think that institutional and individual investors are like frogs put into a pot of water set to heat to the boiling point. At first, the temperature is fine and it slowly heats up. Eventually it gets so hot that it is unbearable and the owners scream, “Get me out of here”. The chart below shows how poor the returns have been over the last 3-years for the kind of asset allocation that existed in the latest NACUBO study (compared to a 60/40 stock bond mix, let alone 100% US equity).

Source: New York Times, October 12, 2012

THERE IS NOTHING TO INDICATE THAT THE FROGS ARE JUMPING OUT OF THE POT. In our opinion, the more years it takes for people to come back out of exile, the more imprisoned investors are going to feel by their portfolio makeup. For example, trying to make a retirement living out of US treasury and certificate of deposit interest rates is like building pyramids out of straw!

The US stock market can have a significant correction at any time and most likely will every year. It is likely to suffer a bear market once every 5 years on average. Those mini-famines are the price you pay to earn 8-10 percent over long-term holding periods (15-20 years). We aren’t concerned about the short-run outlook for US stocks because most of the money hasn’t even begun to come back from voluntary exile. When commodities and bonds inflict pain on the investment frogs, prices could be quite a bit higher for the kind of companies which fit our eight proprietary criteria.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

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