Archive for the 'Investing' Category

Why We Use Dividend Paying Stocks for Income

At 401 Advisor, LLC one of our three investment strategies for our client assets is a model that primarily uses dividend paying stocks to produce cash flow. Dividends can be paid out to clients for income, or reinvested to provide portfolio growth through the purchase of additional shares.

The one disadvantage of choosing a strategy that narrows the investment options (only stocks that pay dividends in this case), is that different subsets of the overall market will both outperform and underperform the entire market for different periods. From the beginning of May through the end of June was one of those periods of underperformance for dividend paying stocks. Not only did we see underperformance, but we also saw uncharacteristic volatility. I wrote about this on my post on June 21, “Market Comment“.

This is when having a strategy that fits your investment goal is important. Matching strategy to objective allows us to focus on what is most important to our clients. In this case, income and preferably rising income.

 I looked at 17 of our portfolios’ top holdings. While this would not necessarily represent any individual’s portfolio, every one of our Dividend and Growth Opportunity strategy investors will hold several of these stocks. For the averages I just used a simple average and looked at stocks only, none of the ETF holdings.

I first looked at each holding’s price performance from May 1, 2013 open through the close on June 21st. I then looked at the first dividend paid in 2013 and the most recent and annualized the two to look at the difference.

Taking a simple average the “portfolio” has a year to date price gain of 4.17%, but a loss of 4.67% from May 1 through June 21. For an investor on January 2nd, the portfolio yield would have annualized to 4.57% for the year based on first quarter dividend payments. But based on the most recent dividend payments, the annualized yield would be 4.69%, a raise of 2.56% (annualized to 5.12%). Plus dividend stalwarts McDonalds and Verizon  typically raise dividends in the third quarter. With official inflation running at about 1.5% our income investors have received a nice raise in return for the volatility we’ve seen this year. In fact our largest loser in the portfolio, UHT has actually increased its dividend from $0.62 per share to $0.625 per share. Relatively small, but showing that a yield increase is not dependant on price appreciation.

For a retiree especially, income and income growth are their typical primary investment objectives. Well chosen stocks, based on free cash flow analysis, will continue to pay, and as we’ve seen actually increase dividend payouts, even in declining markets.

Despite recent weakness and some continuing uncertainty over rising interest rates, a focus on dividends is a long term profitable strategy. Below is a graph from Ned Davis research that shows that dividend paying stocks, and specifically stocks that increase their dividends outperform the overall market.




What to Make of the Current Market High

Much is being said about the S&P 500 breaking through its former daily high set in 2007. The question seems to be whether this is the end of a bull market or the start of a new one?

First, let’s put this into perspective. Below is a chart of SPY – the SPDR’s S&P 500 Index tracking ETF showing monthly returns since 1997. Many pundits like to point out that we have been in a four year bull market, and therefore, this rally is extended and due to come to an end. This is simply false.

What we have been in for four years is a bear market recovery, as anyone who invested prior to 2008 can tell you, we have simply had a long 4 year slog to recovery from the financial crisis induced crash.

Figure 1 SPY 1997 – Present, monthly returns.



Second, from a longer term secular reference, we have really been in a 13 year bear market and recovery cycle dating back to the 2000-2002 tech wreck market crash. Since the market peak in March of 2000, we have not gone above, and stayed above that level for 13 years now. This is the definition of a secular bear market.

The good news is that secular bear markets do end.

Below is a chart from Crestmont Research showing the history of secular markets in the U. S. since 1900. As you can see the market’s history consists of long periods of rising markets (green bars) followed by relatively flat periods (red bars). However, “flat” describes the period from beginning to end of the period. Flat periods, or secular bear markets, can be filled with large declines and recoveries.

Chart 2. History of Secular Markets



So are we going higher? Hard to say.

 I know you want an answer.

My point is not that we are at the beginning or end of a bull market. My point is simply that just because we have re-attained prior market highs, does not in and of itself mean much of anything as to which way this market goes from here. It is simply not that simple. But it makes for good headlines.

What I will say is this: The overall stock market is not “cheap” at these levels – in terms of corporate earnings. However, it is extremely hard to factor in just how much of an effect the Federal Reserve’s series of Quantitative Easings have had on valuations. In English – low interest rates make stocks more attractive. We have extremely low interest rates, albeit artificially low due to the Fed.

If the Fed can successfully keep interest rates low this year, and without a major “event” the market could finally breech its former highs, and stay above them before the next bear market rears its ugly head.

That said, in practice we remain cautiously optimistic. We continue to look primarily for undervalued dividend opportunities in our Dividend Growth portfolios. We are fully invested in our seasonal ETF growth strategies.

Top Dividend Picks for Retirees – 2013

I am of the firm belief that the only way for a retiree to invest with an anticipation of receiving a life-time income from their investments is to buy dividend paying stocks. Ideally, big blue chip stocks with not only a history of paying dividends, but of increasing their payouts as well. We know the names; IBM, P&G, Coke a Cola (KO), Exxon… Unfortunately, many retirees having seen incomes frozen for a decade and portfolios ravaged by two bear markets, find that the 2%-3% dividend yields offered by these companies is just too little to pay today’s bills and enjoy even a modest retirement. To accommodate retirees with higher income needs I try and mix in a combination of the tried and true blue chips with a few “high yielders” to bring up the overall portfolio yield. I define “High Yielders” in today’s market place as stocks with a minimum of a 5% yield (more than double the S&P 500) and still hope to stretch that into the 7%+ range without adding too much risk.
So with that in mind here are two of my top picks, one in each category for 2013.

McDonald’s (MCD)
When looking for sustainable and increasing future dividends stodgy and boring, and needed is a very good thing. While food in general is a need, some might question the “need” behind a Big Mac. But ask any working single mom, and “Kid’s Meals” is on the need list. While third quarter 2012 saw an uncharacteristic slow down in earnings, for retirees we are looking at cash flow. Even with a drop in share price over 17% at its lowest, MCD announced an increase in their quarterly dividend in November from $.70/share to $.77/share. This marked the 36th consecutive year of increasing their payout.
Fundamentally MCD is an all weather stock. In poor economic times harried workers “downsize” their eating out bills by going from the mid-tier Applebee’s and Olive Gardens to McDonalds. Also expect more competition for Starbucks as MCD develops their “Café” identity. MCD has a strong international presence for growth in developing markets, and offers a currency hedge to the dollar.
Their payout ratio is modest at 52%, P/E at the market level at 15.35 for 2013, and modest growth expectations in the high single digits for 2013. MCD is a solid 3.47% yielder providing income stability and a likely raise well into the future.

SeaDrill Limited
While SeaDrill Limited (SDRL) provides a wild ride (Beta 1.97) it can be worth it for the investor needing a little extra juice in their dividend payouts as SDRL has a current yield of 9.21%.
SDRL is in a solid and growing business. They provide deep water and submersible rig platforms for oil and gas drilling and exploration. Their largest division “Floaters” are fully leased for 2013.
Of course no company sports a (%+ yield without their being question marks. For SDRL there are two major market concerns. The first is debt. Simply put SDRL is considered a “highly leveraged” company.
This is fine as long as cash flow can support the debt. Recently SDRL’s stock took a tumble when they agreed to sell their tender rigs division. While accounting for a small portion of cash flow, any disruption is seen as a concern. However, SDRL also announced that they plan on using the proceeds to invest in more floaters – a higher revenue source per rig, and as mentioned above, their current inventory is fully leased. Bottom line, by the end of 2013 revenues should be up, not down without an increase in debt.
Market concern two is that SDRL paid two dividends in December 2012. Their normal December dividend and a prepayment of the March 2013 dividend. For new investors, if SDRL maintains their 2012 payouts, this would mean a yield of about 6.14% vs. the reported yield of 9.21%. However with a projected P/E of 11.61 for 2013, and earnings growth potential, I see SDRL as a way to boost income in a very solid industry and a very solid capital gain potential as new rig development and leasing accrues revenue to their earnings.

Portfolio Alert

In my last post I said that we were growing increasingly concerned over the deteriorating market since last week’s election.

A key area of support historically has been the 200 day moving average (DMA). The DMA is just the average price of a stock or an index for the past 200 market days, or approximately one year. When the current price drops below the average price of the past year, it has been common to see a much deeper decline. While it is always tempting to say, “This time is different” things rarely really are different. The reasons the market may go down, or up, will always be different, but the actual market cycles are really fairly consistent.

As of the market close on Thursday the 15th, SPY – the S&P 500 tracking ETF, has closed below the 200 DMA for 4 of the last 5 days. We consider this to be a very bearish sign. So far, we have sold 20% of our most volatile holdings in our ETF Seasonal Growth strategies leaving us with a 25% cash position. In our income strategies we have sold up to a 20% position and have also kept that in cash. Our smaller growth accounts that only trade one security are all in cash. Our 401(k)’s are still fully invested. Due to the trading restrictions in 401(k) plans we do delay our buys and sells to try and avoid “whipsaws.” That is getting a signal to get right back into the market after a sell signal. This can result in trading restrictions from the 401(k) plan.

Looking forward, we will continue to sell holdings in our growth strategies, and buy a “short ETF.” A security that goes up, when the market goes down, to further hedge our accounts. Our dividend portfolios will go short with 20% of their holdings. I’ll also look at holdings and focus on defensive industries. Currently we are over weighted in energy and I plan on continuing that overweighting. I would expect the 401(k) accounts to go to cash in the next couple of trading days, unless we see a dramatic improvement in the market.

Look for future posts as we do make portfolio adjustments.

Post Election Outlook

US markets have sold off since Tuesday’s election. At this point I’ll take a politically neutral stance and repeat what I said before the election. The market wanted to see a “mandate” win. And while the electoral college spread was fairly wide, the popular vote was very close. It is now a wait and see game on whether the Republicans feel as if they had enough support to threaten blockage of any tax increase proposals to deal with the fiscal cliff. Or if they feel the better strategy is to acquiesce to the victor. Until this issue is resolved the markets will probably stay unhappy.

In addition, with 24/7 election coverage over, there once again has been a realization that we are not alone in the world. Europe is back to the forefront as well as the Middle East and China.

Last week the S&P 500 breached its 200 DMA and closed just below that level. As a function of our strategy and remaining disciplined to that strategy we expect to start the process of taking defensive action in accounts if it looks like the market will close below the 200 DMA consistently this week.

As a side note, I have said repeatedly that the specific strategy that one uses to trigger defensive action isn’t crucial because no single strategy can be the best for all occasions but they can be reasonably effective in protecting against large declines. For example the RBS Trendpilot funds take action after five days below the 200 DMA, Jack Ablin from BMO waits until the SPX goes 5% below the 200 DMA. Our actual sell signal uses the SPX Total Return Index which adjusts for dividends reinvested in the index. This too gives us a delayed signal.

In terms of thinking about what sort of defensive action to take, a reason to give the market the benefit of the doubt and not get too aggressive is that the 200 DMA is still sloping upward and likely to do so for quite a while yet. One reason to not give the market the benefit of the doubt is that in terms of normal cycle duration (both for the economy and the stock market) we are late in the cycle. There is no way to know with certainty if we are at the end of the cycle but by definition if it is late in the cycle then it is close to the end of the cycle.

Right here right now there is no way to know if the market is on the verge of going down a lot. We may all have an opinion, or not, and some will be right and some will be wrong. Being right is far more difficult than the simple action of sticking to whatever strategy was laid out before the market started going down. The idea there is that a strategy laid out before the market started going down was done so with no emotion involved. Anyone may or may not have an emotional reaction but the important thing is not succumbing to the emotion, all that needs to be done is to remain disciplined and we all have more control over that than being correct right now about whether this is or is not going to be a large decline.

Hopefully the market will take back its 200 DMA this week and we won’t have to deal with this now but the important thing is the no matter what we might want we will take action consistent with being disciplined to our stated strategy. I will disclose any defensive action we take on the blog.

Market in Perspective

You would think that the markets have been through the greatest rally of all time, and the biggest crash – all over the past 2 ½ months from the way the news has been reporting on the market. Of course heading into the home stretch of a fairly contentious Presidential election doesn’t do much too calm things either. Not to minimize the importance of global events, but the U.S. stock market is a reflection of the U.S. economy. We all already know about the fiscal cliff. Earnings expectations are low for the third quarter. Economic data has been “mixed” for months. So with all of this priced in, where exactly do the markets stand?

The chart below in Figure 1, was a bit of an eye opener to me. The graph shows the total return for each market rally – post a 30% or more market decline, since 1900. The “You Are Here” dot is in the bottom left. So on a long term horizon, the post-financial crisis rally has barely started. However, just to the right, is the “2002 blue dot.” Which shows that, by comparison, if this is another bear market rally the market could well be at an intermediate top.

Figure 1. Stock Market Rallies


For perspective I find it best to look out over the longer term and then narrow the time frame. One of my favorite charts of all time comes from In Figure 2 below, Crestmont does a wonderful job of breaking the market down into bull and bear cycles. Clearly the market moves up in spurts, (secular bull markets), and sideways (secular bear markets), for extended periods of time.

Figure 2. Secular Bull and Bear Markets


From this perspective the secular bear that started in 2000 is painfully obvious. It’s also hard to define the current market as in either a bull or bear phase. Yes, we’ve had a four year rally, but hardly to levels you could define as “high”. In terms of time, it would be prudent to start anticipating a return to a secular bull, but both the 1902 and 1965 Bear markets lasted longer – 18 years and 15 years respectively.

Zooming in on the past decade simply confirms Figure 1 and 2.

Figure 3. Spy 1996 – Present, Monthly


While the rally has been formidable, it is not unique. The pre-2000 rally was sharper and from lower levels. And we have not quite hit the 2007 peak. What is interesting for perspective, is that the last leg of the pre-financial crisis rally saw 13 out of 16 months posting positive gains. This past bounce of four consecutive positive months is by comparison hardly “extended.”

And finally let’s zoom in on a closer look. Figure 4 is a year to date look at SPY. While the current level seems “high,” again looking at Figures 1-3 all we can say is the market has had a decent recent run, but there is nothing here to say whether the market is “high” or the rally is getting overextended after just 3 months.

Figure 4. Spy Year to Date, Daily


Points that I’ve highlighted:

  • In April – May of this year you had a solid double top before the market gave way into the early summer. Double tops are one of those technical formations that do tend to be significant – if only because everyone expects them to be.
  • To the right I’ve highlighted the recent high with a horizontal line. The highlighted area also contains a continuation of the current trend line. Ideally the market breaks through the horizontal line, and peaks, no earlier than, the rising line around the point of the green arrow, before we start seeing a bit of a correction. This would indicate a significant break through resistance and avoiding the double top.
  • An alternative is that the market hits the horizontal line and falls. This will immediately bring warnings of a sell off from the media – citing the double top in April – May.
  • Looking at the channel formed by the rising lines, the market is in a definite bull trend. The fact that the last two bottoms were well above the bottom support line is very bullish. How it reacts to resistance at 147.50 will be interesting.
  • A drop should only be to 143.30, before a pause and re-assessment.
  • The 200 Day Moving Average is in Blue. The first sign that a sell off will be significant will typically be when the 200 SMA begins to slope down – that is a long way away; currently 136.38.
  • The last candle on the chart (Monday 10/1/2012, 2:30pm), is a negative formation. If the market doesn’t rally into the close, we could be testing support (bottom rising line) before we test resistance.
  • While October is historically volatile, the fourth quarter is historically strong in election years.

Despite what I would consider to be horrible news in the mid-East and Europe, reasonably bad news from China and Japan, and decidedly contradictory news in the U.S., this appears to be a market that really wants to go higher. Even the bears have to admit that with recent news and data, this market really could (or should) be much lower.

The fundamental positives seem to be that:

  • P/E ratio is stuck at “average”. While bull markets tend to originate from single digit P/E’s, Bear markets start at P/E’s closer to 20 than 10. According to the trailing S&P 500 P/E is 16.77 and forward P/E is 13.98. Considering the Fed has pledged a zero interest policy through 2013, or until unemployment is at “acceptable” levels, a P/E closer to 20 is justified using a discounted earnings calculation. Don’t discount the distortions caused by Fed intervention.
  •  Earnings expectations for the third quarter are low. Contraction across most sectors is expected. It’s easier to beat low expectations than high ones.

The negatives: virtually all things macro and political.

Portfolio Strategy
For our Growth strategies we have moved into out seasonally strong, higher beta portfolio. If October becomes too dicey I can sell our two most liquid ETF’s (IWO and IWP) and go short (SH) to hedge the portfolio. With two of ten holdings being GDX (Gold Miners Index) and UNG (Natural Gas Index), we’d then have a very low correlation to the market if I do need to hedge. But for now I’m in the bullish camp through the end of the year.

Ditto for our Dividend strategies, I’ve moved into more aggressive and higher yielding names. Again with selling of just two securities I can hedge the portfolio by buying SH. Even with 5% cash and 20% in non-yielding SH the portfolio will have a 4.5% dividend yield to coast through trouble. But if the market behaves itself in October, we should be set through the end of the year.

Bottom Line
Positioned for a continuation of the rally, but ready to hedge if fundamentals become too strong of a drag. I need evidence from the market before I get Bearish.

Investment Outlook – September 2012

Our portfolios have lagged the overall market since mid-June when the recent market rally started. The portfolios have continued to hold our “low beta” selection of dividend paying stocks and ETF’s.

The rationale to remain in “coast” mode is that it is my opinion the rally has been primarily fueled by Mario Draghi’s comment that the ECB stood ready to take “any action necessary” to preserve the Euro and by extension the EU, including Greece. The problem is that the ECB does not have the authority to follow through on such statements. Simply put, the ECB is prohibited from “printing” the money they would need to implement a U.S. style round of quantitative easing (QE). It is pretty well accepted, that absent such action, there is just not enough economic backing to backstop the financial bleeding in Europe.

The bull argument continues with the “bad news is good news” theme. With China’s economy softening, U. S. economic data “softening” at best, the economic stage is being set for a global simultaneous easing from China, the U.S. and Europe.

The best bull argument is that things are getting worse, so there has to be Fed intervention which would fuel a global rally. I am not willing to buy into that scenario. However, if we actually see such action come to fruition, we will change the look of our portfolio, jump on the bandwagon, and look for higher beta (more aggressive holdings) to capture gains if the rally truly emerges. With the risk to the markets extremely high if such hopes don’t materialize, I will wait for the Central Banks to literally “show me the money” before making a commitment with client’s hard earned investment dollars.

Below is a screen shot from comparing my Dividend and Income Plus Portfolio (Dark Blue line labeled “Manager”)to the S&P 500 for the prior 90 days. While the underperformance is clear, so should be our lack of volatility. In fact the portfolio sports a beta of .63, or a volatility measure of 37% less than the S&P 500. And even with our 20% cash position, the portfolio is sporting a very healthy 4.5% dividend yield.


Combining the low volatility with the dividend yield, we are extremely happy with our overall performance, especially for the risk adverse income investor, such as a current or near retiree. Furthermore looking at the graph below, again from, I zoom in our recent performance.

Since the recent market peak on August 17, the portfolio has outperformed the market by .7% over just two weeks.

Our ETF Seasonal Growth Model has had similar relative results.

Mario Draghi has “leaked” his plan for ECB bond buying and the reaction has been a big yawn. I expect September to be a volatile month and expect to close the recent gap in relative performance with the S&P 500. Primarily by maintaining value while the S&P 500 corrects.  I hope to be true to our motto, “It is not what you make, but what you keep that matters”.

Looking a little further out I do expect the post election rally. I have picked more aggressive investments to rotate into our portfolios if the rally does materialize. Until then patience is prudent.

Individual performances will vary depending on timing of investments, withdraws, specific holdings and allocations. Past performance does not indicate future results. All investing involves risk. Please consult with your financial advisor on suitability of any investments specifically mentioned prior to investing.

It’s All About the Bazooka

The markets have been rallying since June 26th when Mario Draghi, the ECB President, announced that the ECB would do “ whatever it takes” (or as Wall Street terms it “will bring out the bazooka”), to save the Euro. Add in the fact that August has been the number one month for the NASDAQ and Russell 2000 indices in election years, and this month’s rally has come as no surprise.

But remember in investing, it is not what you make but what you keep that matters. The following is from Megan Greene, of Roubini Global Economics, and reprinted in John Mauldin’s “Outside the Box” Newsletter.

As usual, this has been a lazy August, but we do not expect the quiet to last. Indeed, for the second September in a row, developments in the eurozone (EZ) have the potential to be highly dramatic.

Greece: The troika is due to return to Athens in September and make a ruling on whether to release additional tranches of funding to Greece. If the troika decides to cut the taps off—and we don’t think it will—then Greece would default and exit the EZ. The Greek government aims to renegotiate the second bailout program when the troika returns to town in September. If the troika plays hardball and does not grant the Greek government any concessions, then the governing coalition would likely collapse. Also in September, the Greek parliament will have to pass a number of measures to generate €11.5 billion in savings for 2013-14. With a high degree of austerity fatigue in Greece, we can expect social unrest.

Portugal: With Portugal starting to slip on its fiscal targets, we expect Portugal to begin negotiations on a second bailout package. Currently, Portugal is meant to return to the markets in 2013 but, with bond yields well above sustainable levels, we regard this as highly unlikely.

Spain: The auditors Deloitte, KPMG, PwC and Ernst & Young are due to present their full reports on the capital needs of Spain’s financial sector in September. The findings of this report will be used to determine the exact amount the Spanish banking sector will need to borrow from the EZ’s bailout fund, the European Financial Stability Facility (EFSF).

Italy: The Italian general election campaign will begin in earnest in September. Although polls point toward a center-left-led coalition, Italian politics is at its most fluid state since the early 1990s and, with so many voters still undecided, it is impossible to call the election.

Germany: The German constitutional court is due to vote on the legality of the ESM (the successor to the EFSF) and the fiscal compact on September 12. We expect the court will deem the ESM legal but, if this does not occur, it would serve a major blow to EZ policy makers, who have committed the ESM to potentially purchasing sovereign debt in the primary markets.

France: The French government is scheduled to unveil its 2013 budget in September. Markets will be disappointed if it does not include large spending cuts, but the announcement of further austerity risks riling trade unions and stoking civil unrest.

Netherlands: A general election is scheduled for September 12. Recent opinion polls suggest the ruling right-of-center VVD will be unable to form a right-of-center majority
government. Consequently, coalition negotiations are likely to be protracted. The left-wing, euro-skeptic SP may win enough votes to be the second-biggest party. This would make it more difficult for the new Dutch coalition to secure parliamentary support for additional support measures for peripheral EZ countries.

Eurozone: There is a progress report on establishing the ECB as a single banking supervisor due out in September. Given that many details have not been hammered out yet, there is a chance that the progress made on this first step toward a banking union will disappoint.

In terms of the broader EZ developments, we expect the Greek government to collapse by the end of the year, and a Greek exit in early 2013, followed by an exit by Portugal by end-2014. Moreover, we expect Spain to receive official support from the EFSF/ESM in late 2012 after the ESM has been fully ratified (the second half of September at the earliest), while Italy will hang on longer but will eventually need support as well.

Add in that seasonally September is one of the worst months for U.S. markets and September could bring back a level of volatility that we have not seen for awhile. While I have been in the camp that just can’t comprehend how Europe holds the Euro together – the amount of money involved is truly staggering, even by U. S. debt and bailout standards, I do think German Chancellor Merkle acquiesces and gets out of the ECB’s way. In other words after a month of haggling, name calling, bluffs, and counter bluffs, the ECB turns on the printing presses before year end. Greece may or may not be invited to the party. But not sure it matters in the medium term.

I have done a 180 and think that even Greece will stay in the Euro. Consider down the road five years if Greece leaves, devalues their currency and now “competes” with the rest of Europe. Shipping costs, one of Greece’s actually industries, plummet due to the devalued Drachma, which revives the glory days of Greek shipping. Tourism is flourishing as it costs have as much to vacation in Greece as anywhere else in the Euro controlled Europe. Wouldn’t Spain, Portugal, Italy, and Ireland all be looking on and reconsider their own Euro status? Just sayin’.

Back to matters at hand. For lots of reasons, including those already mentioned, I think this rally is getting a little long in the tooth. I wouldn’t be jumping in now. Let’s get into September, see if we can find a better entry point, but be ready to invest aggressively in October.

October, November and December are traditionally strong months, especially in election years. If Draghi gets the green light to bring out the bazooka, i.e. print endless amounts of money, the big worry over the market will be lifted. Fiscal cliff will be put off, and China will be priming their pump over the winter. Forget politics, focus on the markets and we could have a strong fourth quarter, but expect things to get worse in order to make them better.

Is There Value Left in Low-Beta Market Sectors?

Today’s post appeared at and is reprinted below for my blog readers and clients, Aug. 9, 2012:

Low-beta stocks have been a good alternative for clients who want safety without going to cash. But value plays in this sector are getting hard to find—even utilities are getting overvalued. Is it time to move to higher beta investments? Here’s what to watch.

Since April we’ve been following our revised “Sell in May” seasonal discipline. Most advisors are probably aware of the Wall Street adage “Go away in May; don’t come back until November.” I adapt the “sell” part to “rotate to low-beta holdings.” While the strategy has worked out well so far this year, there are still nearly three months left in the seasonally soft period before the “buy” signal hits in late October or early November.

At that time I will start looking to rotate into higher-beta holdings. But that leaves the question of what to do with new investors. Is this the time to be committing more money to the same low-beta holdings? The answer provides an interesting look at the markets.

Despite what appears to me as horrid fundamentals, the market, as shown in Figure 1 using SPY, the S&P 500 tracking ETF, is definitely in a technically solid bull trend, and looks like it could challenge the year’s highs set in March.

Figure 1: SPY One Year


Despite what seems like endless whipsaws from Europe’s news de jour, volatility has actually diminished substantially since the third and fourth quarters of 2011. This can be seen in Figure 1 of SPY as well as in Figure 2 of the VIX.

Figure 2: VIX One Year


In Figure 3, I have graphed the S&P Low Volatility Index (green line) vs. the S&P High Beta Index (blue line) for the past year. While the low-volatility index is the clear winner for the past year, its relative gains have come from the “sell” seasons, to the left and right of the two vertical lines.

Figure 3: SPLV vs. SPHB One Year


This brings me back to my specific question “After a run of low-beta vs. high-beta stocks, is there still value to be found in low-beta holdings?” In general, considering the market and macro view as having turned somewhat negative, low-beta holdings can be a source of security in turbulent times. However, if they have become too pricey, could it be a better strategy to literally “go away” into cash? Or, if you see this as a market/economic bottom, is it time to look at higher-beta offerings?

It boils down to P/E

My basic definition of “value” lies in the P/E ratio. Ideally I want to be buying holdings with a P/E somewhat lower than the market. I see this as both offering a bit of a cushion to the downside and as offering greater upside if the P/E rises to a market multiple from “P” expansion relative to the “E.”

In Table 1, below, I have created a chart of the top sector holdings for both SPLV and SPHB. Then I looked at the current P/E ration for each sector, using the SPDR sector ETF or the Vanguard ETF for the Information Technology sector.

Table 1: Select Sector P/E Ratios

Source: Bill DeShurko,,

From the table above, we see SPLV is trading at a P/E premium to SPY of 17%, while SPHB is trading at a discount of over 11%. Unfortunately, there is not enough history to the indexes to look at historic relationships, so we’re left to guess at what levels mark over- and undervalued. However, I do think it is a safe conclusion to say that SPLV is getting pricey, and therefore may not be the low-beta play that one might be expecting should we have a market decline.

Delving deeper into the data, in Table 2, I ran a simple screen on utility stocks (the criteria are listed in the footnote on Table 2). Suffice it to say these are pretty simple criteria and rather low hurdles to expect a stock—especially a utility company stock—to clear.

Table 2: Utility Stock Value Screen


Using the same screener, only screening for U.S. stocks and the utility sector produces a list of 97 potential candidates. Finding only four that meet this screen tells me that utilities are getting overvalued. The last time utilities approached P/Es this high was the end of 2011. As seen in Figure 4, utilities flattened out for the first five months of 2012, the area between the vertical bars, as the “E” caught up with the “P.”

Figure 4: XLU One Year



The market has gone into a “risk on, risk off” mode for the last couple of years. You can see the cycle by comparing Standard & Poor’s Low Beta and High Volatility indexes. Clearly, on a one-year basis (as seen in Figure 3), the low-volatility index is the clear winner. The question is, can low-volatility sectors, and stocks still outperform, or do they need to correct to bring valuations down?

The answer to where to invest lies in your macro view of the market. As long as uncertainty persists, (fiscal cliff, election, Europe, slowing global economies), there will always be demand for lower risk investments. And in a near-zero interest rate environment, low beta stocks have offered an investment option. But after a solid run, relative to higher risk (higher beta) stocks, are lower risk holdings setting up for a normal mean reversion correction?

Conversely, if your confidence is high that we somehow muddle through our current list of problems, valuations are getting very compelling, as historical “growth” sectors are becoming value plays.

In digging deeper into the index holdings, there do appear to be a few value plays left. Personally, I’ll try to continue to find the individual stocks that meet my criteria in the low-beta sectors. But I’ll be watching my screens carefully for SPHB to gain solid momentum over SPLV. Historically the market is positive after presidential elections, and SPHB being both a bullish play and an undervalued bullish play could add some pop to client portfolios for the year.

Pre Mid-Year Wrap Up

As we head into the July Fourth Holiday I’m struck by what an appropriate holiday to be celebrating based on our financial markets. No, not so much the Patriotic implications, but the fireworks!! Every day when I come to work and power up the computer I’m expecting to see new “fireworks” exploding on my screen as some new catastrophe of the day has lopped a couple hundred points off the DOW.

Instead, surprisingly to me, the markets have really fared fairly well this year with SPY, the S&P 500 tracking ETF up just over 5% for the year.

Unfortunately 5% can be wiped away in just a couple days if fireworks are really ignited. Not surprisingly, I’ve received several phone calls from investors asking what our outlook and strategy are as we head into the second half of the year.

Since today is the 3rd, and a shortened trading day, and I plan on going out of town for the rest of the week, this will not be THE 2nd half of 2012 Outlook piece. But I thought I’d send out a brief note before what will be a very long weekend for some of us.

Bottom line the economic news that hit over the weekend was pretty bad. Virtually every single country showed flat or slowing growth in manufacturing as indicated by the PMI numbers that came out over the weekend. And yet the market has held up. The one Wall St. axiom I quote often is, “Don’t fight the Fed.” Meaning when the Federal Reserve is easing, or trying to stimulate the economy, the stock market will generally react favorably. Today, it is not just the U S Fed that looks to be moving closer to a new round stimulus. With the generally weak global PMI numbers China is loosening their lending requirements, Brazil looks to be reversing their currency policy and strengthening the Real before the World Cup and Olympic events that they will be hosting, and of course the big one, Germany has blinked first, and looks like they will accept a more accommodative policy for the rest of the Euro Zone.

Our strategy has changed a bit. I have sold SH, an ETF that acts in the reverse of the S&P 500, from our income portfolios. This 20% position did very well dampening our volatility for May and June, but I think July may be a decent month as Central Banks look to speed up the printing presses. Until next week, I’ll leave this in cash or a neutral position and see what happens when Wall St. returns from the Holiday. This does leave our targeted income a little short, so I will be making a move soon. Our ETF Seasonal Growth strategies are unchanged. Our low Beta (volatility) strategy has done very well since our “go away in May” sell signal tripped early in mid April this year.

For those of you that trade on your own, UNG the ETF that tracks natural gas has been moving up, and is right at resistance at $19.50. If it holds above this level it could be a buy. For really aggressive investors, Brazil might be a play heading into the winter Olympics. Neither holding would be appropriate for our strategies.

Of course past performance is no guarantee of future results. And any ideas suggested in this post require significant additional research before implementing into any portfolio. • 937.434.1790

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Join 504 other followers

Go to webpage:

Go to webpage:

Follow me on Twitter

on Amazon

Link to my weekly column.

Charles H. Dow Award Winner 2008. The papers honored with this award have represented the richness and depth of technical analysis.