Uncorrelated Correlations: Market Correlation Changes Create Opportunities

Falling Correlations in the Stock Market

In 2008-09, the sell-off in stocks was deep.  Nearly every company in every industry was hit hard – regardless of credit quality or fundamentals.  Coming out of 2009, stocks continued to trade very much in lockstep with one another.  Companies with very different fundamental values were trading up or down by very similar amounts.  In other words – the market was not rewarding strong companies more than weaker ones. 

Over the past 5 years, that trend has steadily been reversing.  The CBOE Implied Correlation Index measures the average correlation of stocks that comprise the S&P 500 against the S&P 500 Index itself.  The Implied Correlation Index has been on a year-over-year decline since 2008-09.  The trend has continued this year, as correlations have trended downward from year-end 2012 highs above 70 to current levels in the low 50’s (see chart below).

S&P 500 Implied Correlation Index Historical Data (CBOE.com)

Stocks are no longer moving together quite as tightly as they have over the last 5 years.

The ABC's of Dividend Investing, Part III: So Goes the Dividend, So Goes the Stock

I am reposting this blog.  Several people indicated there was something wrong with the formating that did not allow them to read two paragraphs near the bottom.  Hopefully this version is competely visible.

When I first thought about writing the ABC’s of Dividend Investing, the third edition was supposed be the big wrap-it-up-with-a-bow offering:  A summation of everything we have learned in all these years of managing money reduced to a couple of paragraphs.  The truth is I have spent all afternoon staring at Oregon’s snow-tinged, Three Sisters Mountains attempting to tap into a narrative that would help tell the story in a simple, understandable way.  I can’t do it.  The principles of dividend investing are reasonably straightforward; however, the process of determining what to buy or sell and when to do it is incredibly complex.

Nowhere Else to Go: Rising Rates Won't Be Enough to Curb Stocks

Fed Taper Talks Drive Rates Higher

Since Fed taper talks began in early May, 10-year U.S. Treasury yields have risen from a 1.6% to 2.9%, an increase of nearly 100%.  At their current pace, rates will be near 4% by year-end.  Worries that the Federal Reserve might taper their Quantitative Easing program have speculating futures traders betting on higher rates in the near-term.  We don’t believe it.

The question is not as much where rates are headed, but how quickly they will get there.  We agree that
rates will eventually normalize.  However, we do not believe rates will continue to rise towards 4% in the same linear path they have held over the past few months.  Even the most aggressive analyst’s interest rate projections don’t have interest rates reaching 4% until 2015.  In the short term, we believe the 10-year U.S. Treasury yield will likely stabilize within a trading range of around 2.5% to 3.0%.

The ABCs of Dividend Investing: Part II, Dividend Growth Is Vital

In our previous blog on dividend investing, we offered some of our dividend research and a general theory on how to think about the importance of both dividend yield and dividend growth.  In this edition, we will share some of our insights into how different combinations of dividend yield and growth act in various kinds of stock markets.

When most people think of dividend-paying stocks, often they incorrectly think that such companies are unusual.  The truth is among the 500 stocks in the S&P Index, nearly 400 of them pay a dividend.  What makes a company valuable, according to our research, is that it has raised its dividend persistently and consistently over a long time.  We do not place hard limits on these descriptors because we do not want to eliminate companies that have persistently and consistently raised their dividends but not on a calendar basis. United Technologies (UTX), for instance, increases its dividend every six quarters; thereby, having years where it does not increase its dividend on a calendar basis.  The every-six-quarters approach is consistent and persistent, but UTX does not make the lists of dividend stars because of the occasional calendar miss. 

Our research in the dividend world began with the utility sector in the late 1980s.  That early research revealed some surprising results. 

When the Dust Settles: Dividend Stocks Still the Place to Be

Tilt to Growth Stocks is Paying Off

At the beginning of the year, investors were driving up the prices of defensive stocks (health care, utilities, and consumer staple) over more growth-oriented stocks (financials, cyclical, industrials. In a traditional bull market, growth stocks lead the charge. At the time, investors were willing to pay almost as much per dollar of earnings (expressed by the P/E ratio) for safety and income as they were for growth. In fact, utilities were trading at a higher P/E than industrials and financials. The market was being driven by fear and growth stocks were not being rewarded.

We knew that would change. As we stated in our May 20, 2013 Take Aways, “The market will begin to be driven more by greed than fear. As that happens, we expect investors to shift their focus from defensive sectors to more growth-oriented, cyclical stocks.”

Cross Currents Aplenty, Improving Fundamentals Will Prevail

Earnings Growth: Modest Growth, but Better-Than-Expected

Company earnings and revenue growth for the S&P 500 during the 2^nd quarter have both surprised to the upside. Earnings growth, as reported so far, has been about 3% higher than the 2^nd Quarter in 2012 – led by Financials up nearly 9%. Revenue growth so far has been just under 1.5% – despite the Energy sector reporting 9% lower sales than a year ago.

Prior to the release of 2^nd quarter earnings, the expectations were very low. While these revenue and earnings growth appear to be modest, they were better than expected – which gave the market a lift. Nearly 70% of companies beat expectations.

Companies are Not Cutting Back

There is little evidence that businesses have achieved earnings growth from cost-cutting. According to JPMorgan research, only 9 of the 228 companies that have reported thus far have boosted earnings based on higher sales and lower expenses. Companies have grown earnings by increasing revenue, investing in new technology, research and advertising – not by reducing expenses as many analysts had feared.

Take Aways

We would like to introduce you to a feature on our website called the “Investment Policy Committee (IPC) Take Aways”.  The Take Aways are weekly write-ups of discussion from the Investment Policy Committee meetings.  They summarize our collective thoughts about the economy, interest rates, stock prices, news, and other topics of interest.They are not meant to replace the blog, but rather to provide a way to convey our views about the markets on a more timely and regular basis.  Below are the Take Aways from the most recent IPC meeting (7/29/13):