The Morning Call
The Market
Technical
Another day of
high volatility. Yesterday, the indices
(DJIA 17813, S&P 2063) soared, closing within uptrends across all
timeframes: short term (16450-19222, 1907-2888), intermediate term (16472-21627,
1734-2448) and long term (5369-18860, 783-2083).
In the last week’s
trading, the pin action has destroyed those developing pennant formations,
penetrating both boundaries. So I am
scratching them as Market guideposts.
Aside from the boundaries of the major trends, the only other
resistance/support levels are the all-time closing highs (17986, 2080) on the upside
and the mid December lows (17288, 1970) on the downside.
Volume
was up; breadth improved. The VIX plunged
13%, ending below the lower boundary of its very short term uptrend (a finish
below this trend today will confirm the break), within a short term trading
range, an intermediate term downtrend and right on its 50 day moving
average. While supportive of yesterday’s
stock market moon shot, its trading was much less decisive than that of the
overall market.
The
long Treasury took another hit, closing below the lower boundary of its very
short term uptrend (a finish below this boundary today will confirm the break)
but within uptrends across all other timeframes and
above its 50 day moving average. The
much needed consolidation of TLT seems to have begun. More consolidation.
GLD
rose again, closing in a very short term uptrend, a short term uptrend and an intermediate
term trading range and above its 50 day moving average. I continue to await some consolidation before
starting to nibble.
Bottom line: the powerful intraday volatility continues. As I noted yesterday, such erratic behavior
argues that I dismiss most of the interday movements as offering little
technical guidance. So right now, the
focus is on the uptrends as well as the most recent discernable support (the
mid December lows) and resistance (the former all-time closing highs) levels.
Both the TLT and
GLD have been on a sizz and need consolidation---which the long Treasury is now
getting. A similar move in GLD will
likely precipitate some buying in our Portfolios.
Bull and bear
market durations (short):
Fundamental
Headlines
The dearth of US economic stats continued with only
a single datapoint reported yesterday---weekly jobless claims which fell more
than anticipated. Again nothing.
Of
course, the big news was the new ECB QE which was structurally in line with the
rumors that I reported on Wednesday but of a somewhat larger size. It seems likely that Draghi or one of his
lackeys leaked the E50 billion a month figure knowing that E60 billion would be
an upside surprise and make the QE lemmings wee wee in their pants---and he
nailed it. Since a 1.5% move up in the
Averages says all we need to know about how positively investors interpreted
the new ECB QE, I include the below as a counterpoint”
This from Peter Boockvar---finally the details
(short):
And from the Reformed Broker---so what? (medium):
Beyond the ‘QE hasn’t worked for anyone else’
argument, here are some specific problems that might impact the efficacy of ECB
QE (medium):
Investor implications of ECB QE (medium):
And like our own QE, the new ECB QE will likely
provide cover for no fiscal reform---which is what is really needed (medium):
***overnight, the December Chinese manufacturing
PMI was up more than expected.
Bottom line: we now have the most long promised economic
plan in world history and the investment universe once again reacted with
euphoria (no ‘sell the news’ it). I
heard no one on CNBC discuss the fact that QE hasn’t worked in the US or Japan. I didn’t hear any analyst say that the most
visible response to ECB QE will be a weak euro (strong dollar) and that will hurt
foreign profits of US companies (1) something we don’t need more of, given the
recent string of lousy earnings reports
and (2) in particular if investors insist on giddily marking up US
equity valuations.
I repeat my
conclusion from yesterday’s Morning Call: ‘However,
even if we get the best outcome that we can hope for---meaning Europe avoiding
a recession and just muddling through at a lesser growth rate than the US---that
is the assumption plugged into our Models.
In short, we have the best case scenario in our Valuation Model and
stocks are still extremely overvalued.’
EU equity valuations (short):
Deflation is a problem for all central banks
(medium):
Thoughts on Investing from Larry Swedroe
It’s well
documented in the academic research on stock returns that value stocks have
outperformed growth stocks. And we see the higher returns to value stocks in
almost all countries. And not only has value outperformed growth, but the
persistence of its outperformance has been greater than the persistence of
stocks outperforming bonds.
When
implementing a value strategy, many different metrics can be used. Among the
most common are price-to-earnings, price-to-sales, price-to-book value,
price-to-dividends and price-to-cash flow. All the various approaches produce
results showing that value stocks have had higher returns than growth stocks.
And the various measures produce similar results, with the weakest results
coming from the use of the dividend-to-price ratio.
Given the
similarity in results, the price-to-book ratio has been used the most because
book value is more stable over time than the other metrics. That helps keep
portfolio turnover down, which in turn keeps trading costs down and tax
efficiency higher.
Recently,
some passively managed funds have moved away from the single-screen metric, as
their research indicates that using multiple screens produces better results.
Bridgeway and Vericimetry are two examples of fund families that have adopted
this approach. In addition, the funds based on the RAFI indexes also use
multiple screens (sales, earnings, dividends and book value).
In other
words, the search for the best metric to use when implementing a value strategy
continues.
To help us out, let’s look at what the authors of the
2012 study “Analyzing Valuation Measures: A
Performance Horse-Race Over the Past 40 Years,” found. They covered the 40-year period 1971-2010
examined the returns to a variety of value metrics:
· Earnings to Market Capitalization (E/M)
· Earnings before interest and taxes and depreciation and
amortization to total enterprise value (EBITDA/TEV). (Total enterprise value is
defined as market capitalization + short-term debt + long-term debt + preferred
stock value – cash and short-term investments.)
· Free cash flow to total enterprise value (FCF /TEV)
· Gross profits to total enterprise value (GP/TEV)
· Book to market (B/M)
· Forward earnings estimates to market capitalization
(FE/M)
Following
is a brief summary of their findings:
· Alternative valuation metrics such as EBITDA/TEV, GP/TEV
and FCF /TEV provide economically
and statistically significant alphas; that is, returns after adjusting for
exposure to the risks of stocks overall—small and value alike.
· EBITDA/TEV is the best valuation metric to use as an
investment strategy relative to other valuation metrics. The returns to an
annually rebalanced equal-weight portfolio of high EBITDA/TEV stocks earned
17.7 percent a year. They also produced a three-factor alpha of 2.9 percent.
· Cheap E/M stocks (value stocks) earned 15.2 percent a year,
but showed no evidence of alpha after controlling for market, size and value
exposures.
· The academic favorite, book-to-market (B/M), tells a
similar story as E/M, and earns 15.0 percent for the cheapest stocks, but with
no alpha (not surprising, as value as measured by B/M is one of the factors).
· FE/M is the worst-performing metric by a wide margin.
· When they analyzed the spread in returns between the
cheapest and most expensive stocks, EBITDA/TEV is the most effective measure.
The lowest-quintile returns based on EBITDA/TEV return 8.0 percent a year
versus the 17.7 percent for the cheapest stocks. Using E/M, the spread is 5.8
percent—9.4 percent for the expensive quintile and 15.2 percent for the cheap
quintile.
· There is weak evidence that FCF /TEV
can identify overvalued stocks, as the -2.0 percent alpha on the most expensive
FCF /TEV quintile shows.
· There is little evidence that a particular value strategy
outperforms other metrics during economic contractions and expansions.
The
authors also examined the hypothesis offered by proponents of long-term
valuation metrics that “normalizing” earnings decreases the noise of the
valuation signal and therefore increases the predictive power of the metric.
Shiller’s PE10 (averages earnings over 10 years) is a commonly used metric.
They found little evidence that normalizing the numerator for a valuation
metric has any ability to predict higher portfolio returns. If anything, the
evidence suggests that the one-year valuation measure is superior to normalized
metrics.
The
authors concluded: “The evidence suggests that EBITDA/TEV has historically been
the best-performing valuation metric based on a variety of analyses.”
It will be
interesting to see if the latest research gets incorporated into investment strategies.
News on Stocks in Our Portfolios
o
Rockwell Collins (NYSE:COL):
FQ1 EPS of $1.10 misses by $0.02.
o
Revenue of $1.23B (+17.1% Y/Y) beats
by $10M.
o
Kimberly-Clark (NYSE:KMB):
Q4 EPS of $1.35 misses by $0.02.
o
Revenue of $4.83B (-1.4% Y/Y) misses
by $80M.
Economics
This Week’s Data
Other
More
on global income inequality (short):
Politics
Domestic
International
Yemen’s US backed government resigns (short):
Ukrainian
forces abandon Donetsk airport (short):
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