I recently turned neutral on stocks after their extraordinary strength in October. While there are numerous factors that affect stocks and numerous--and often conflicting--indicators, a good (contrary) indicator of investor sentiment is the VIX Index of option volatility.
In trying to identify market tops, there is little information in a low VIX level (which indicates widespread investor optimism), as low readings can persist and stocks continue rising for an extended time.
A high VIX reading, however, has been associated with market bottoms over the past fifteen years. When the VIX has been above 28.5 (less than 20% of the time), the S & P 500 Index has returned 40% annualized. It closed today at 34.5. Persistence at this level on the VIX Index, or even higher levels, will increase my confidence that stocks have greater near-term appreciation potential.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1216
Thursday, November 17, 2011
Monday, November 14, 2011
Two Quality Investments
Though the sharp rebound in stock prices over the past month has caused me to be cautious about the stock market overall, I still find individual stocks that remain attractive. Merck and Vodafone are two examples that meet my criteria for competitive and financial strength, attractive valuation, and sustainability.
Last week Merck announced a dividend increase and an positive update of its prospects for important new drugs. The dividend yield is 5%, which compares quite favorably with the overall stock market and for savings and fixed-income alternatives. Merck generates significant excess cash after capital spending and dividend outlays, and it sells for less than 10 times estimated 2011 earnings per share.
Vodafone was featured favorably in this week's Barron's magazine. Its 45% ownership of Verizon Wireless will soon show tangible results, as Vodafone will receive a $4.5 billion dividend from the joint venture. Since Vodafone will pass the Verizon Wireless dividend on to shareholders, the total dividend yield by Vodafone will be 7.5%. That even exceeds the yield on many junk bonds. Vodafone also has leading market positions in key markets and a management that is committed to returning cash to shareholders through dividends and share buybacks. The stock sells for only 10 times earnings, despite the substantial stake in Verizon Wireless that is not consolidated on Vodafone's financial statements.
In addition, both Merck and Vodafone are widely recognized as sustainability leaders. The companies' performance on environmental, social, and governance (ESG) criteria is exceptionally admired. As positive sustainability assessments are increasingly recognized as an indicator of management quality that leads to superior returns for investors, the prospects for these two investments are indeed bright.
Steve Lehman
LehmanInvest.blogspot.com/
Last week Merck announced a dividend increase and an positive update of its prospects for important new drugs. The dividend yield is 5%, which compares quite favorably with the overall stock market and for savings and fixed-income alternatives. Merck generates significant excess cash after capital spending and dividend outlays, and it sells for less than 10 times estimated 2011 earnings per share.
Vodafone was featured favorably in this week's Barron's magazine. Its 45% ownership of Verizon Wireless will soon show tangible results, as Vodafone will receive a $4.5 billion dividend from the joint venture. Since Vodafone will pass the Verizon Wireless dividend on to shareholders, the total dividend yield by Vodafone will be 7.5%. That even exceeds the yield on many junk bonds. Vodafone also has leading market positions in key markets and a management that is committed to returning cash to shareholders through dividends and share buybacks. The stock sells for only 10 times earnings, despite the substantial stake in Verizon Wireless that is not consolidated on Vodafone's financial statements.
In addition, both Merck and Vodafone are widely recognized as sustainability leaders. The companies' performance on environmental, social, and governance (ESG) criteria is exceptionally admired. As positive sustainability assessments are increasingly recognized as an indicator of management quality that leads to superior returns for investors, the prospects for these two investments are indeed bright.
Steve Lehman
LehmanInvest.blogspot.com/
Sunday, November 13, 2011
Cautious About Stocks (Continued)...
Though I can still find individual stocks that sell for attractive valuations based on p/e or price to free cash flow, the widespread pessimism and oversold nature of the stock market a couple of months ago have been reversed after one of the strongest months for the stock market on record.
Two recent indicators now signal caution at least. The put/call ratio for the S & P 500 has fallen sharply, indicating growing optimism. Also, a key survey of individual investors--the American Association of Individual Investors--shows nearly twice as many bullish respondents as bearish ones. This is almost a complete reversal from a couple of months ago.
So while I continue to encourage the purchase of selected individual stocks that meet strict quality and valuation criteria, I have a neutral position on the stock market overall.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1264
Two recent indicators now signal caution at least. The put/call ratio for the S & P 500 has fallen sharply, indicating growing optimism. Also, a key survey of individual investors--the American Association of Individual Investors--shows nearly twice as many bullish respondents as bearish ones. This is almost a complete reversal from a couple of months ago.
So while I continue to encourage the purchase of selected individual stocks that meet strict quality and valuation criteria, I have a neutral position on the stock market overall.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1264
Friday, November 11, 2011
ECRI Leading Economic Indicator Flashes Warning
I generally think that too much emphasis is placed on economic forecasts when making investment decisions. However, recessions are not good for stock prices. The Economic Cycle Research Institute's weekly leading index has an excellent record in forecasting recessions--and the latest readings are ominous.
Since 1967, when the ECRI weekly leading index has declined below its longer trend level (the 98-week trendline), a recession has followed. The only major exception was early last year, when a decline was not followed by recession (though it was hard to tell).
The weekly index has been falling steadily in recent weeks. So perhaps investors in the stock market should not get too comfortable in the weeks ahead, despite the encouraging news from Europe.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1265
Since 1967, when the ECRI weekly leading index has declined below its longer trend level (the 98-week trendline), a recession has followed. The only major exception was early last year, when a decline was not followed by recession (though it was hard to tell).
The weekly index has been falling steadily in recent weeks. So perhaps investors in the stock market should not get too comfortable in the weeks ahead, despite the encouraging news from Europe.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1265
Wednesday, November 9, 2011
Earnings Expectations Remain High
Expectations in investing--as in life--are crucial to satisfactory outcomes. In investing, high expectations for company performance--earnings growth particularly--tend to lead to disappointment. Conversely, low expectations tend to lead to positive surprises--and profits. This is why value investing has superior results over time, as cheap stocks tend not to be as bad as the consensus thinks and expensive stocks reflect the outstanding growth prospects that are obvious to even casual market observers.
Forward earnings growth expectations for the stock market overall are an important indicator of market expectations. Over the past 32 years, when consensus earnings expectations for the next twelve months for S & P 500 are at least +14.2%, the S & P has had negative returns (excluding dividends). When earnings growth expectations are moderate (earnings growth of 4%-14.2%), returns have been 7% annualized. When expectations are low, however (less than 4% growth), the annualized return on the S & P 500 has been 17%.
At the end of October, the consensus earnings growth forecast for the next twelve months was 14.1%. This is down from a high of more than 21% earnings growth that was forecast early in 2010 (before the big decline in stock prices). Even further declines in growth forecasts to more realistic levels would help support stock prices.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1276
Forward earnings growth expectations for the stock market overall are an important indicator of market expectations. Over the past 32 years, when consensus earnings expectations for the next twelve months for S & P 500 are at least +14.2%, the S & P has had negative returns (excluding dividends). When earnings growth expectations are moderate (earnings growth of 4%-14.2%), returns have been 7% annualized. When expectations are low, however (less than 4% growth), the annualized return on the S & P 500 has been 17%.
At the end of October, the consensus earnings growth forecast for the next twelve months was 14.1%. This is down from a high of more than 21% earnings growth that was forecast early in 2010 (before the big decline in stock prices). Even further declines in growth forecasts to more realistic levels would help support stock prices.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1276
Tuesday, November 8, 2011
Neutral on Stocks
Amid the frenzy over the U.S. debt ceiling extension and the financial crisis in Europe some weeks ago, I thought the odds favored a significant rebound in stock prices largely because of widespread pessimism among market participants. With October's returns being among the highest on record, what is the mood among market participants now, and are stocks still attractive?
Not surprisingly, the sharp rebound in stock prices has lifted the mood of investors, as reflected by various sentiment surveys. One particular indicator of market sentiment is the VIX Index of option volatility. Low levels of the VIX indicate complacency among market participants, or even high levels of optimism. This condition does not, however, mean that a sharp market decline in imminent. Stock prices often have remained at high levels or risen even further when this condition has existed.
The converse has a much better predictive record. When the VIX Index is at high levels, it indicates high levels of fear, and such periods tend to be followed by a sharp rebound in stock prices. Specifically, when the VIX is above 28.5, the annualized return on stocks has been 39% on the S & P 500 going back to 1996. August was a good example, as the VIX was above 40. A sharp rebound in stock prices followed. When the VIX is below 28.5, the return on the S & P has been negative (excluding dividends). Today the VIX is at 29, right on the cusp.
For this and other reasons, I am neutral on stocks at current levels and recommend holding significant cash (outright or in high-yield bonds) in order to have ample resources for the next significant decline in stock prices.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1276
Not surprisingly, the sharp rebound in stock prices has lifted the mood of investors, as reflected by various sentiment surveys. One particular indicator of market sentiment is the VIX Index of option volatility. Low levels of the VIX indicate complacency among market participants, or even high levels of optimism. This condition does not, however, mean that a sharp market decline in imminent. Stock prices often have remained at high levels or risen even further when this condition has existed.
The converse has a much better predictive record. When the VIX Index is at high levels, it indicates high levels of fear, and such periods tend to be followed by a sharp rebound in stock prices. Specifically, when the VIX is above 28.5, the annualized return on stocks has been 39% on the S & P 500 going back to 1996. August was a good example, as the VIX was above 40. A sharp rebound in stock prices followed. When the VIX is below 28.5, the return on the S & P has been negative (excluding dividends). Today the VIX is at 29, right on the cusp.
For this and other reasons, I am neutral on stocks at current levels and recommend holding significant cash (outright or in high-yield bonds) in order to have ample resources for the next significant decline in stock prices.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1276
Tuesday, November 1, 2011
Stock Market Thoughts
Stock market results the last two days show that the support for the market is a mile wide but only an inch deep. Correlations among stocks are at historic highs, so it seems that on any given day, the Big Money either embraces risk or shuns it, driving stocks sharply up or sharply down. It is so hard to invest in such a market environment that individual investors can be forgiven for shunning the stock market and just buying bonds, or even insurance annuities.
I haven't given up on stocks, at least where there is a real business underneath the stock. I particularly seek businesses that produce useful products, are managed by individuals with high integrity and foresight, and which seek to ameliorate the adverse effects of their operations on the environment. Such managers increasingly integrate environmental, social, and governance (ESG) principles in their business operations.
I also favor companies that generate substantially more cash from their operations than is needed to continue the business. Good things tend to happen when astute, shareholder-oriented managers have additional capital to allocate by raising dividends, repurchasing shares (at undervalued levels), reducing debt, or making acquisitions that enhance the business prospects. Of course, as a contrarian, value- and income-oriented investor, I favor such stocks, especially when they have dividend yields of 4% or more and still generate surplus cash. And such stocks are available.
So with bond yields unusually low and dividend yields on select stocks quite high (though not for the overall stock market), if this correction in stock prices continues, I'll be back in the market buying stocks.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1218
I haven't given up on stocks, at least where there is a real business underneath the stock. I particularly seek businesses that produce useful products, are managed by individuals with high integrity and foresight, and which seek to ameliorate the adverse effects of their operations on the environment. Such managers increasingly integrate environmental, social, and governance (ESG) principles in their business operations.
I also favor companies that generate substantially more cash from their operations than is needed to continue the business. Good things tend to happen when astute, shareholder-oriented managers have additional capital to allocate by raising dividends, repurchasing shares (at undervalued levels), reducing debt, or making acquisitions that enhance the business prospects. Of course, as a contrarian, value- and income-oriented investor, I favor such stocks, especially when they have dividend yields of 4% or more and still generate surplus cash. And such stocks are available.
So with bond yields unusually low and dividend yields on select stocks quite high (though not for the overall stock market), if this correction in stock prices continues, I'll be back in the market buying stocks.
Steve Lehman
LehmanInvest.blogspot.com/
S & P 500: 1218
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