Friday, August 31, 2012

Don't Fight the Fed--Not!

One of the most relied-upon adages for the stock market was popularized three decades ago by market technician Martin Zweig on the PBS series, "Wall Street Week With Louis Rukeyser."  Zweig observed that stock prices tended to rise when the Federal Reserve was easing monetary policy, and that they tended to fall when policy was being tightened.

That adage seemed to be at work again today as stock prices rose after Fed Chairman Ben Bernanke indicated that more active easing may be imminent. 

I think this is one time not to follow the adage, as Fed easing has been anticipated for some time.  Market sentiment measures reflect too much optimism for me, so I still advise caution--and patience--in anticipation of better values to come.

Steve Lehman

S & P 500:  1407

Tuesday, August 28, 2012

Take Profits Now

I reiterate my advice to reduce stock holdings at current levels.

There seems to be a building consensus that government authorities in the U.S. and Europe will soon engage in concerted actions to add further stimulus to markets and economies.  In addition, even though Chinese economic activity is slowing markedly amid a glut of various products, the Chinese authorities are also expected tow provide stimulus.  And yet....

I have found that market sentiment measures are highly reliable for short- to intermediate-term readings on the stock market.  That's not so for technical measures, though I do refer to several.  And while valuation is incontrovertibly the most important determinant of long-term returns from the stock market, it is useless in the short term.

Several of my favorite measures of market sentiment are now flashing strong warning signals.  The put/call ratio, for example, has been particularly reliable over the past year.  It showed a relatively high degree of pessimism at the beginning of June, for example.  Now after many stocks have risen 15-20% in price over the past two months, the put/call ratio is showing the highest degree of optimism in about a year.  Similarly, the Consensus, Inc. and MarketVane surveys of institutional investor sentiment are at high (bullish) levels.

When these conditions have existed in the past, they usually have been followed by declines in stock prices.  I know that any significant news about Europe, China, U.S. politics, or geopolitics in the Middle East could seem to be a catalyst for a large move in stock prices (either up or down).  I think, however, that they will be explanations for what the market seems likely to do anyway.  And that, in my opinion, is to go down.

Steve Lehman

 S & P 500:  1408

Thursday, August 23, 2012

Apple Hits Record High Share Price

This week Apple set a record when its stock market value reached $623 billion.  This topped the prior record set by Microsoft thirteen years ago.  The Microsoft record coincided with the mania for technology stocks in the late 1990's, while there is no such mania today. 

Yet, there is still a significant parallel between the two.  In both cases, at the time of the peak market value, it was inconceivable among investors that such a dominant company would not continue to dominate its field for years to come--and provide continued superb gains for its investors.  But after its peak, Microsoft stock has fallen from $59 a share to $31 a share over those thirteen years.  It is still a fine company, but has not been a fine stock to own over the last thirteen years.

Similarly, Cisco Systems had a stock market value of more than $500 billion in 2000, when its stock peaked at $79.  It now sells for $19.  Cisco's dominance has faded, but it still is a highly profitable company.

Unlike the examples of Microsoft and Cisco, Apple stock does not seem expensively valued based on current earnings.  There is probably not a more esteemed company in the world today, but the stock price reflects that.

I admittedly was not astute enough to buy Apple stock anytime over the past five years, so these comments may reflect envy more than objective analysis.  I am, however, struck by the similarities with other dominant technology companies whose stocks became poor investments.

Steve Lehman

Tuesday, August 21, 2012

Stock Market Decline Likely

Investor complacency has risen along with stock prices as this rally since early June matures (funny how that always seems to happen).  

Market sentiment measures now show widespread complacency, if not wild-eyed greed, among stock market participants.  The Consensus Inc. and Market Vane surveys of professional investors are at historically high levels, and the put/call ratio is relatively low.  These, along with other measures that I follow, tell me that stock prices are vulnerable to a setback in the weeks to come. 

I reiterate my advice to raise cash.

Steve Lehman

S & P 500:  1420

Monday, August 20, 2012

Interest Rates Move Up

One of the most widely held views among elite market observers has been that U.S. Treasury securities will be terrible investments over the next decade.  The explosion of the Federal Reserve's balance sheet--"money printing"according to the Fed's critics--is expected to lead to inflation.  In addition, when the Fed's unprecedentedly loose monetary policy is reversed--presumably when the economy improves--interest rates will rise, and bond prices will fall.

Bonds, especially U.S. Government bonds, have been superb investments for a long time.  Interest rates have been in a declining trend since 1982, which has led to rising bond prices and excellent risk-adjusted returns.  Though bond market cycles historically have been much longer than those of the stock market, the current 30-year bull market in bonds has seemed to many to be on borrowed time.

So it surprised me to notice that the yield on the 10-year Treasury note has risen from a recent, all-time low of 1.4%, to 1.8%.  This move in bond yields was matched by a breakdown in the utility sector of the stock market.  Utility stocks have historically been sensitive to changes in interest rates, but with the sector quite overvalued and now yielding relatively little, perhaps even modest increases in bond yields will cause heavy selling of utility stocks and rotation into other sectors.

Is this the beginning of a bear market in bonds?  If so, it would be a shock to many individual investors, who have shifted many billions of dollars from stocks to bonds in recent years.  I suspect that a financial shock or economic slowing this fall will provide support to bonds.  I do think, though, that the clock is ticking for the bond bull market.  

Does that mean that stocks would have a bull market as funds shift back to stocks?  With U.S. stocks approaching the highest point in the last four years, I'm skeptical.  The S & P 500 Index, for example, is approaching its two prior highs, in 2000 and in 2007, both of which were major tops before brutal declines.  Market sentiment measures seem to optimistic to sustain a strong move higher in stock prices from current levels.

With many stocks up 15-20% in price in the last two months, I strongly urge caution by equity investors.  Now is an excellent time to replenish cash reserves for better future buying opportunities.

Steve Lehman

S & P 500:  1415

Friday, August 17, 2012

The VIX Flashes a Warning

The VIX index of options volatility is a widely watched measure of stock market sentiment.  High levels of the VIX--generally greater than 30--have indicated high anxiety or pessimism among investors.  Such high levels of the VIX have been excellent signals to buy stocks, as major market lows have been associated with high VIX levels.

The reverse--low levels of the VIX--has been associated with low levels of anxiety among investors, or even complacency.  Low levels of the VIX  would seem to flash signals to sell stocks.  However, the sell signal of a low VIX has not been as clearly reliable as the buy signal of a high VIX level.  Yet, stock market gains have historically been minimal--or slightly negative--when the VIX index is at low levels, even higher than its current level of 14.

The VIX index is now the lowest it has been since 2007, which was a major top in the stock market.  Though the S & P 500 has risen about 3% since my recent advice to raise cash (and it could well move higher still), I think the current level of the VIX and the complacency it reflects strengthen the argument for caution.

Steve Lehman

S & P 500: 1415

Sunday, August 12, 2012

Another Acquisition Goes Sour--We Shouldn't Be Surprised

The evidence is clear that the vast majority of corporate acquisitions are mistakes for the acquiring company.  Acquisitions are usually made at large premiums to the current price of the acquired company's stock, which of course is a windfall for the acquired company's shareholders.  But so often the premium paid for an acquisition (which goes on the acquiring company's books as an intangible asset) is later written down significantly, if not completely, by the acquirer.

The latest example is Hewlett-Packard's 2008 acquisition of Electronic Data Systems for $13.8 billion.  Hewlett announced on Wednesday that it will take an accounting charge of $8 billion, which is a 58% writedown only four years after the acquisition.  That charge (along with an additional charge of $1.6 billion for layoffs) will cause Hewlett to report a loss of $4.31 to $4.49 per share when it announces its quarterly results on Aug. 22.

Since the $8 billion writedown is an "extraordinary" development, the company and the analysts that cover it will focus on "operating" earnings from ordinary business operations.  Yet, the $8 billion writedown is indeed a reduction in the accounting net worth of the company (assets minus liabilities).  

That is why when I analyze a company's financial position, I not only consider the net debt relative to shareholders' equity, but I also consider the amount of intangible assets on the books relative to shareholders' equity.  For as we saw recently with grocery retailer SuperValu, when a company with substantial debt and large intangible assets ("goodwill" and other intangible assets) has to write down the intangible assets to reflect an impairment in their value, the reduction in assets (and net worth) causes the debt ratios to soar--and perhaps imperil the company's existence as a going concern.

The lack of acknowledgement of huge mistakes by emphasizing "operating" earnings rather than net income is a primary reason for the overestimation of corporate earnings and a corresponding underreporting of the price/earnings ratio of the stock market.  The use of "forecasted operating earnings" for the next twelve months rather than the actual net income of companies over the last twelve months almost always makes the stock market look cheaper than it really is.

So while it is good that new CEO Meg Whitman is recognizing the huge mistakes of her (perviously lionized) predecessor Mark Hurd and is more accurately reporting the financial state of Hewlett-Packard, it remains that the bias on Wall Street is one of a rosy hue.

Steve Lehman

Friday, August 10, 2012

Are Dividend Stocks Overvalued and Riskier Than We Think?

I'm not the first to notice that if the Bush tax cuts are not extended in their present form that the tax rate on dividends for affluent investors will rise from 15% to 40%.  If that happens, that would seem to significantly reduce the appeal of stocks with the highest yields that have benefitted so much from the stretch for yield in the absence of attractive alternatives in savings deposits or government bonds.

Sectors that have been in particular demand are utilities and real estate investment trusts (REITs).  The electric utility sector is historically quite overvalued, and the dividend yields seem paltry to me given the heavy debt loads and high dividend payout ratios of the stocks.  REITs also are in this category, as most of the companies are serial issuers of stock, which dilutes existing shareholders.

Though some companies such as Apple are initiating dividends, the dividend yield on the S & P 500 is currently only 2%, compared to its long-term norm of 3.6%.  With steady consumer stocks such as Colgate-Palmolive and Coca-Cola selling at 18 times estimated 2013--not 2012--earnings per share, I am concerned that this area no longer offers significant value.

So even though a cursory look at the S & P 500's chart since the major low of early in 2009 indicates that the rally is intact with higher highs and higher lows, I still suggest raising cash now for better buying opportunities in the stock market at lower prices.

Steve Lehman

S & P 500:  1401

Thursday, August 2, 2012

Thanks for That Advice!

I know that the job of analyzing companies and making buy or sell stock recommendations is very difficult.  It is also extremely lucrative, so one can reasonably assume a high standard.  Yet all too often, "sell side," or Wall Street, analysts fail the investors--professional and amateur alike--who rely on their advice.

As with economists and market strategists, there is considerable "career" pressure not to be outspoken and wrong.  Of course, being outspoken and right is fine, but the penalty for the opposite is much greater.  So, like with many other human activities, there is a "herding" tendency among economists, strategists--and analysts.  They tend to move en masse to change their opinions in response to news.   But with analysts, responding after the fact to developments concerning a company and its stock is much too late to do any good in most cases.

I recently wrote about "Operation Barn Door," the tendency of analysts to lower their rating on a stock after bad news--often disappointing earnings results--and after a stock has plummeted immediately after the news, before an investor can respond.

Today there was the opposite--upgrading the rating on a stock after unexpectedly good news.  First Solar reported strong earnings for the second quarter, and the stock surged 24%.  One analyst upgraded the rating on the stock to neutral from sell, but two analysts raised their ratings from neutral to "buy" after the stock surged more than 20%.  Perhaps the stock will continue to rise, but as the stock had already risen about 20% from its recent low going into the earnings report, the stock is now up about 45% in the last two months, and now it's a good time to buy?

Again, it's a very difficult job to make stock recommendations, and the outcomes are glaring if the recommendations are bad.  But why not admit missing one, rather than scrambling to change the rating on a stock to make it appear that the recommendation was made in time for an investor to act on it?

Steve Lehman

Wednesday, August 1, 2012

Hit the Beach!

There is an adage on Wall Street that goes, "Sell in May and Go Away," because of the historic tendency for poor returns from April 30 through October 31 over the decades.  The evidence is quite compelling.

I'd add a new one this year:  "Hit the Beach This August."  With the share prices of many leading companies 15-20% higher over the past two months, I suggest raising cash and taking a break from the markets.  It's a fine time to unplug for a couple of weeks (at least) and not think about markets. 

I think there is too much complacency about expected support for stock prices by central bankers in the U.S. and Europe. 

I am willing to miss further gains in stock prices over the next couple of months.   I do not agree with the many market strategists who assert that equity valuations are quite reasonable at current levels.  With p/e ratios of many leading companies in the high teens on current-year earnings while profit margins are at record levels, I disagree.

The only way to argue that equities are undervalued here is to compare equity dividend yields (or worse: the "earnings yield" or the inverse of the p/e ratio) to the record-low yields on U.S. Government securities.  I've heard the argument that there is no alternative to investing in equities before.  I didn't think that was a sound case then, and I don't think it's sound now.  Wait for better buying opportunities.

Steve Lehman

S & P 500:  1375