Category: SP500

Happy Days

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January 27th, 2013

This past week, Republicans in the House passed a bill to delay the raising of the debt ceiling till May.  The S&P500 crossed 1500, nearing the high of 1550 it set in October 2007.  This past week, money flowing into equity mutual funds finally surpassed the flows into bond funds (Lipper Source)

As the saying goes, “The trend is your friend.”  When the current month of the SP500 index is above the ten month average, it’s a good idea to stay in the market.

So, happy days are here again!  Well, not quite.  Household net worth is still climbing but has not reached the 2007 peak.

But when we step back and look at the past thirty years, household net worth is better than trend.

Asset bubbles overly inflate and deflate net worth, which includes the valuation of assets like stocks and homes.  An asset bubble is like a Ponzi scheme in that those who get in toward the end, before the bubble bursts, often suffer the worst.

CredAbility, a non-profit credit counseling service, produces a Consumer Distress score that evaluates five categories that have a significant effect on a consumer’s financial stability: employment, housing, credit, the household budget and Net Worth. It has only just broken out of the unstable range into the bottom of the frail range.

The Federal Housing Finance Administration (FHFA) released their House Price index a few days ago.  This price gauge is indexed so that 1991 prices equal $100. The index, which does not include refinancing, came in at $193, or just about 3% per year.  Although housing prices are still depressed from the heights of the housing bubble they are still above the CPI inflation index since 1991.  Housing prices generally rise about 3% – 4% per year, depending on what part of the country you live. 

When we look back twenty years, we can see that housing prices are, in fact, above a sustainable trend line established before the Community Reinvestment Act and the advent of mortgage securitization, both of which undermined rational underwriting standards.

Nationally, we are close to sustainable price trend but still a bit inside the bubble.  Sensing that home prices may have hit bottom, Home Builder stocks as a group are up about 50% in the past year.  Think that’s good?  They rose almost 100% from the spring of 2009 to the spring of 2010, only to fall back again. 

Tight credit, rigid underwriting standards and a still frail consumer will present challenges to the housing market as it climbs slowly out of the doldrums of the past few years.

Predictions and Indicators

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January 20th, 2013

I was talking with someone this week who thought that, this year or next, the financial world would melt down.  This week someone else asked what I thought was going to happen this year.  The S&P 500 index is approaching the highs of 2007.  Is this a good time to invest in stocks?

I don’t know.  In the early 1970s, Alan Greenspan, who would become head of the Federal Reserve in the late 80s, called for a bull market just a few months before the market imploded and lost almost half its value.  Recently released minutes of meetings of the Federal Reserve in 2007 showed that some members were worried about contagion from the decline of the housing market to the rest of the economy but the overall sentiment was that housing and employment weakness was a needed and normal correction to an economy that had gotten a bit too frothy.  No melt down anticipated there.

All any of us can know is what has happened and even that knowledge is imperfect.  Regulators who are privy to information that might spook the markets often conceal that information and hope to contain the damage.  Brokers and managers at large investment houses actually help build bubbles, skimming off fees and derivatives profits in the process.

With an imperfect assessment of the recent events, and a non-existent knowledge of the future, investors face the choice of putting their savings under the mattress or sending out their vulnerable savings into the economic fog.

Over the past few years, I’ve looked at several indicators that have been fairly reliable foreshadowings of coming recessions.  Before I look at those, let’s look at the big daddy indicator: the stock market.  Over the course of a week, millions of buyers and sellers try to anticipate the direction of the economy and corporate profits.  The majority of the time the market does anticipate these downturns but we need to look beyond the main index, the S&P500.  Instead we look at the year-over-year percent change in the index.  Below is a monthly chart of that percentage change.

The percent change drops below zero when the majority of investors do not believe that the market will increase over the next year.  You may also notice that it is a good time to buy the market when the y-o-y percent change declines 15-20%.

When we look at the past twenty years, the lack of confidence has been a reliable indicator of the past two recessions.  The graph below is the y-o-y percent change in a quarterly average of the S&P500.

These charts are easily available at the Federal Reserve database, FRED.  Just type in “Fred SP500” into your search engine and the top result will probably be a link to a chart of the index.  (Link here ) Click the “Edit Graph” button below the chart, then change the Frequency under the resulting graph to Monthly or Quarterly to smooth out the graph.  Just below the Frequency field is a drop down list of what you want to chart.  Select “Percent Change from Year Ago”, then click “Redraw Graph”.  Fred does all the work for you.

As of right now, the majority of investors are somewhat hopeful that there will be an increase in the index in the coming months. 

Another indicator I look at is the y-o-y percent change in the unemployment rate (UNRATE).  This is the headline number that comes out each month.  When the percentage change goes above 0, it’s probably not the best time to putting more money to work in the market.

Although the unemployment rate is still high, the yearly percent change is healthy.  As someone quipped, “It’s not the fall that kills ya, it’s the change in speed when ya hit the pavement.”  The change in each of these indicators is the key aspect to focus on.

Entering “Fred Unemployment” into a search engine should bring up as the top result a link to the unemployment chart.  Follow the instructions I gave for the SP500 and Mr. Fred will do all the number crunching.

Looking at a broader index of unemployment, the U-6 rate, gives no indication of near term economic decline.  Below is the percent change in that index.

Another indicator is New Orders in Nondefense Capital Goods Excluding Aircraft.  As I noted the past few months, this has been worrisome.  We don’t have sixty years of data for this indicator but a decline in the y-o-y percent change in new orders has foreshadowed the past two recessions.  Recent monthly gains give some hope but the decline in equipment investment shows a lack of business confidence for the near term future.

The last index I look at is a composite indicator put together by the National Bureau of Economic Research, NBER, the agency that makes the official calls on the start and end of recessions.  The Coincident Economic Index combines employment, personal income, industrial production, and manufacturing and trade sales.   In a healthy or at least muddling along economy, the percent change should stay above 2.5%.

You can access this by typing “Fred Coincident” into a search engine and the top result should be the graph for this indicator.  Follow the same instructions as above to show the percent change.

Except for New Orders there does not appear to be anything immediately worrisome.  According to Standard and Poors, (the S&P in the name of the S&P500 index), estimated operating earnings for 2013 are about $112 (Source).  At a 15.0 P/E ratio, that would put fair value of the SP500 at 1680, or 13% above its current level of 1486.  The problem is that the estimates of 2013 earnings have been drifting down from $118 last March.

For the past few years there has been a pattern of declining earnings estimates.  Something seems to be getting the way of early optimistic forecasts.  However, even if operating earnings were to actually come in at $100 for 2013, an investor with a ten year or more time horizon couldn’t say that she had overpaid at current market levels.

A favorite theme of 1950s sci-fi movies was the underwater creatures who had been turned by nuclear radiation into a gigantic monsters lurking on the seabed.  The tranquil calm surface of the water gave no hint of the monster swimming beneath the surface.  Then came an upswelling of water seen from the shore, a crashing crest of wave and the creature erupted from the liquid depths. For many investors, there may be that same sense of foreboding.  European banks loaded up on government debt; the Federal Reserve buying the majority of newly issued U.S. debt this past year; trillion dollar U.S. deficits; persistently high unemployment;  perhaps that is why there is so much cash floating around. 

The MZM money stock includes cash, checking accounts, savings accounts and other demand type accounts, money market funds and traveler’s checks; in short, it is money that people can demand now.  The percentage change has moderated recently and shows neither confidence or fear, of investors not knowing whether to step left or right.

For the long term investor, a showdown over raising the debt ceiling in the next few months may present another buying opportunity before the April 15th deadline to make IRA contributions for the 2012 year.

New Orders

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No, this is not about the New Order, the conspiracist’s nemesis.  This is about New Orders of Capital Goods.  When companies forecast sales growth ahead, they place orders for capital equipment to meet the projected increase in demand.  One version of the monthly report on new orders excludes aircraft orders which are volatile; fulfilling the order – the delivery of the new aircraft – are structured over time.

Below is a chart of the year-over-year percentage in new orders excluding both aircraft and defense spending.  I have used quarterly averages to smooth and show the trend. (Click to enlarge in separate tab)

As you can see, there are warning signs of recession or very low economic activity as the quarterly change is close to zero. The most recent monthly change has, in fact, dropped below zero.

The value of new orders has a fairly strong correlation with the S&P500 stock index, adjusted to scale.

Some have suggested that business plans are on hold till after the election and the coming negotiations over budget sequestration, or the “fiscal cliff.”  If so, this may be a temporary drop. The stock index usually either anticipates or is concurrent with the drop in the dollar amount of new orders.  Further gains in the index may be minimal unless this new order indicator of business sentiment turns upward.

200 Day Nudges Higher

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The market is a reflection of hope and fear, of world events that affect each of us, our jobs, our families, our schools, churches and neighborhoods.  The 200 day moving average moves through the minute gyrations of the daily market like a great leviathan, changing its course only gradually.  If you are a Star Wars fan, think of the 200 day as The Force.

For the long term investor, it is wise to buy or sell as this average changes direction.  When we compare a month’s (21 trading days) average of the 200 day to the previous month’s average, we can see these changes in direction.  At the onset of the recession in 1990, the S&P 500 index dropped about 17%.  The recession was fairly short but it was a jobless recovery.  From the October 1990 trough to the end of 1993, the index climbed 60%, then paused and stumbled.

Almost 3 years after the recession had officially ended in March 1991, the unemployment rate was still a lofty 6.5%.

Due in part to the jobless recovery, the federal debt had risen 50% in the four years of 1990 through the end of 1993 and would continue it’s relentless march upwards for several more years.

 

In 1994, the 200 day average waggled in indecision, barely moving during that summer before nudging upwards in August, then falling again in November, before making its decisive move upwards in 1995.  In six years, the index would more than double.  When the 200 day began to roll over in the fall of 2000, the wise long term investor listened to that slow heartbeat and headed for the exits.  In the middle of May 2003, the 200 day began another 4-1/2 year climb up before rolling over in Jan. 2008.  18 months later, the 200 day began yet another climb after the steep descent of the financial crisis of 2008.  Just this past September, the 200 day signaled exit after a tumultuous summer and before continuing unrest in the fall.

A person investing in the S&P500 index who turned when the 200 day average turned would have made 460%, including dividends, on their money since 1994, 81% in the past ten years and that doesn’t include money that could be made in interest while their money sat safely outside of the market mayhem. 

In the last quarter of 2011, the 200 day moving average had been slightly declining but largely flatlining – unchanged – since the beginning of August. A week ago, it nudged higher.  Will this be like the nudge higher in August 1994 that may reverse in a month or two?  Could be. Although the signals of the 200 day average are relatively few, a prudent investor would monitor the situation every week in case this is a “waggle” and not the beginning of a move up.

Leveraged ETFs

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In this blog I focus on economic trends and data that will have an impact on our lives, and in a broader way on our investments. As such, I don’t usually go into the particulars of investing in stocks or bonds. However, I will give a word of caution on a particular type of investment – leveraged ETFs. I recently read that some financial advisors are including these in the portfolios of their clients. These products are suitable short term strategies but be cautious before using them as a core holding.

What is a leveraged ETF? For that matter, what is an ETF? It is a basket of stocks, much like a mutual fund, except that it trades like a stock. Typically, one buys an ETF like you would a stock, in whole lot multiples of 100 through a broker. Like stocks, one pays a commission every time one buys or sells.

What is a leveraged ETF? A basket of trading instruments, lets call them, that seeks to either double or triple the return of a particular index of stocks. You can bet with the index or against it. Since ProShares introduced these ETFs a few years ago, they have become quite popular.

The Ultra series of shares seeks to capture 200% of the upward movement of an index. If an index goes up 5%, an Ultra ETF will go up 10%.The UltraShort shares seek to capture 200% of the inverse movement of an index. If an index goes up 5%, an UltraShort ETF will go down 10%.

Sounds simple but, over time, the percentages can work against you. Let’s look at an example. SPY, or Spdr S&P 500, is a popular ETF that is a basket of stocks that closely tracks the movement of the S&P 500, an index that comprises the market weighted prices of the 500 biggest companies in the U.S. I will compare SPY, the PowerShares UltraShort S&P500 (SDS), and the PowerShares Ultra S&P 500 (SSO).

For simplicity sake, I will round to the nearest dollar. On Jan. 5th, 2009, SPY was at $93, SSO was at $28, and SDS was at $67. Fast forward to 3/9/09, a low point in the market not seen in over a decade, when SPY was at $68. That is a 26% decline from the $93 price at the beginning of January. Let’s look at SSO, which should have gone down twice as much as SPY. On that same day, it closed below $15, an approx 48% decline. That is not exactly twice, but close enough. SDS, the short or inverse ETF, should be up twice the 26% loss suffered by SPY, or 52%. On that day, SDS closed at $115, a gain of almost 60%, more than what we expected. If you had bought SDS on Jan. 5th, you would be singing the “greens” on March 9th.

Let’s continue on. The stock market rallied from that low. On this past Friday, SPY was at $89, gaining back all but 2% of what it had lost since Jan. 5th. SSO should be down about twice that, or 4%, but we find that it closed at $24, a 14% decrease from its Jan. 5th price of $28. If SPY has decreased 2% since Jan. 5th, then SDS should be up 4% since then. But SDS closed at $61, a 9% decline from its Jan. 5th price of $67.

What happened? As long as there is a consistent market direction, up or down, these leveraged ETFs work for an investor. If the market seesaws, the percentages work against the investor.

Due to the popularity of 2x leveraged ETFs from PowerShares, a company called Direxion came out with 3x leveraged ETFs late last year.