The Hunt for Yield Part One: Can Dividends Continue to Grow?

“Those wounds are all the painful places where we fought. Battles better left behind, ones we never sought. What is it that we spent and what was it we bought?”

-Frank Herbert

What quote could better serve up the dilemma facing investment managers as another week of new highs for the S&P 500 which has them wondering, “to chase or not to chase?”  One the one hand, you have a line-up of investment greats like Byron Wein and Jeff Gundlach who think stocks are overbought, not to mention a likely fifth consecutive quarter of declining earnings and on the other…well you have demanding clients who see the market higher and want to participate or an angry MD telling you to clean out your desk if you’re not in the upper quartile this year.  So what do you do?  Continue reading

Is the End of the Fed Bull Cycle at Hand?

While the Yinzer Analyst may had done a magnificent job muddling his case for investors to start shifting their focus to overseas markets where a year of bad news had led to depressed prices but higher return potential going forward. Well someone must have been reading our updates because after a back and forth week, there was a clear shift in momentum today towards international equities while the domestic equity outlook became increasingly muddled as more signs of slowing economic activity ran headfirst into an increase in core PPI here at home.

Staying in the U.S, the Yinzer Analyst’s own momentum models showed a serious breakdown that confirms the end of the great 2012-2013 bull market. We’ve discussed our model previously (here) and while scores haven’t reached their 2014 lows registered on October 13th, or even the December 16th lows, they have recently pulled off something not seen since mid-2012. In a bull cycle, readings as low as we registered on January 6th (97th percentile) should have been meet by a multi-week rally, instead we had a 2 day rally and have found ourselves nearly back to the January 6th lows. It’s tempting to say that a rally is now overdue, but truthfully the market will need some sort of outside factor to give it the shot in the arm it needs. The October momentum lows were only the ‘lows” because comments from St. Louis Fed President Bullard supported the idea of an indulgent Fed same for the short lived rally off comments from Chicago Fed President Evans last week.

But moving beyond the momentum and the Fed, let’s inspect the technical outlook for the S&P 500. Starting with a daily chart, you can see the S&P broke through the rising wedge pattern on heavy volume today, confirming the weakness seen in our momentum models and the divergence in the percentage price oscillator that formed in early December. Even with today’s weakness, the CMF score has continued to improve but largely due to the dropping of the first half of December.

spx

Moving to the weekly chart, you can see the market has continued its breakout from the 2012-2013 Fed inspired uptrend and confirming the end of the bull cycle (whether cyclical or secular remains to be seen.) Having broken below the 20 week moving average on Thursday, it’ll take a major reversal for the market to fight its way back into the uptrend for a third time and seems unlikely at this point.

spxW

While a great deal of technical damage has been done, investors with a long term focus and relying on the simple 2/10 simple monthly moving average crossover will not that a sell-signal has been sent yet. If you stay focused on the intermediate term chart with weekly data, we’re already fighting with the first potential point for the pullback to die out, followed by the 20 week moving average and a second stopping out point just below 1900. If we do break through Stopping Point 1, and find ourselves at Stopping Point 2, the risk becomes the S&P will be stuck in a trading range that could persist until the Fed offers reassurances to the market or raise rates sending sentiment even lower.

spxw2

Back to the Old World:

Shifting our eyes to the east, both the iShares MSCI EAFE ETF (EFA) and iShares MSCI EMU Index (EZU) continued their December weakness in early 2015 and made new lows on January 6th but since then have managed to hold onto their gains while U.S. equities have rolled over. We talked extensively on Monday about why we think European equities could outperform in 2015 and the ECJ’s lead investigator certainly delivered on Wednesday with an opinion that the ECB’s OMT program is legal and although a formal verdict isn’t expected for several months it surely added more lift to the market. Next up is a potential ECB QE announcement next week followed by the Greek elections on the 25th.

Starting with the broader EFA, you can see that while it remains stuck below its 2014 downtrend line while the PPO looks to be turning around. Shifting the focus to relative momentum versus the S&P 500, you can see that today was a stunning reversal out of a seven month long downtrend. For the Yinzer Analyst, stunning reversals are sexy as they get but need confirmation. I wouldn’t mind seeing a strong finish to tomorrow (or even a weak one) but with relative momentum retesting the downtrend line at some point soon.

EAFE

EFASPY1

Moving to just EZU, you can see that its managed to get back above the 2014 downtrend line on a daily basis although like EFA it’ll have to retest it on a weekly basis before investors should get too optimistic. For now EZU is fighting hard to close above prior support and that’s fine in my book. It’s going to be a struggle but we should know within a week or so whether the ETF has what it takes to move forward.

ezu

EZU2

On a relative momentum basis, EZU is still within the downtrend formed in mid-2014 although this week looks to reverse the lackluster performance of the last two. If the trend continues, EZU could potentially breakout next week and signal a major shift in market dynamics is upon us.

ezuspy

Finally, the Yinzer Analyst momentum models show changes underway for both ETF’s although we’re still waiting for confirmation. Like the S&P 500, EZU and EFA made historic momentum lows on October 10th but that only sparked a 2.4% gain for EZU and 4% for EFA over the next 30 days. In the eight days since coming close (but not retesting the actual lows) to the October momentum lows, EZU and EFA have managed a 2.08% and a 2.62% gain compared to a .5% loss for the S&P 500. Still within the realm of horse shoes and hand grenades but worth noting for asset allocation purposes going forward.

One final chart for investors to consider is the performance of the iShares Currency Hedged MSCI EMU Index ETF (HEZU) since that momentum low on October 10th. While HEZU might be a relatively new product, you can see that it has already found favor with investors as it outperformed both EZU and the S&P 500 since 10/10. Clearly investors want exposure to European equities, just not to their currency. But could a QE announcement change investor sentiment on the Euro in 2015?

HEZU

Sunday Night Recap: Can the Last be First?

Amidst the joy that comes from celebrating a winning season with a completely meaningless win for the Buffalo Bills, the Yinzer Analyst turns his thoughts to the opening tomorrow and those last few precious trade days before the start of a new year. There have been a spate of articles lately about how one man’s, or one year’s, treasure can become next year’s trash and to be honest, there’s a great deal of truth to that. Take a look at a Callan table and you’ll see there’s some logic to buying whatever’s been left behind but it’s not consistent. Buying the dogs of the DOW isn’t always a sure thing; check in on Sun America Focused Dividend to see where that got you in 2014. But that has us thinking that it’s time to check in some of 2014’s biggest losers to see how they’re setting up for a brand new year.

Can the Last be First?

First up, the biggest shocker for the broader equity market came from energy stocks; from Jan 1 to June 30th, the Energy Sector Select SPDR (XLE) was up 14.18% versus 6.95% for SPY. Since then, XLE has come crashing down 19.06% as West Texas Intermediate Crude broke down nearly 47% while SPY has chalked up a further 7.59% gain. XLE has firmed up since hitting the 200 day moving average although it has yet to break through the downtrend lines that have held the weekly chart pattern in a downtrend channel since this summer. Currently sporting some of the lowest price-to-earnings multiples to be found in domestic stocks, how long will it be before the can breakout?

XLE

As long as we’re on the subject of hard assets, how about equity precious metals, down 13.11% YTD as concerns over rising inflation become a thing of the past. The Market Vector Gold Miners ETF (GDX) showed signs of life last Friday as the potential for more stimulus in China helped spark a rally for the miners although the technical outlook has been improving for the sector over the course of the month. The miners have broken above the summer’s downtrend line and have spent most of December consolidating but have yet to break through the 50 day moving average or move beyond the longer-term downtrend line you can see in the weekly chart. Speaking from personal experience, until it can close above the 2012 downtrend line, any rally for GDX should be treated warily.

GDX

GDXW

And you can’t talk about gold and oil without talking about Russia, so let’s check in on the Market Vectors Russia ETF (RSX):

Ever since bouncing off $12 close to the 2009 lows, it’s been nothing but up for RSX but remember how quickly this can all turn around. Since 12/17 RSX has moved up 15.98% on….well I’m not really sure. Could it be the promises of China to help bail out Russia if it needs it? The lack of further sanctions? Simply closing out of short positions to reinvest closer to home? RSX may have cleared the steep downtrend line dating back to late November but still has to face to the 50 day moving average and the gentler downtrend line from last summer. Until it can get above that, I’d be very cautious about adding Russian longs.

RSX

And as long as we’re overseas, let’s wrap up this discussion by focusing on the China A-shares market where it’s been nothing but profit since coming close to a double bounce of multi-year lows this spring. It’s been a strange pattern since then;

ASHR

the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) has a nearly parabolic advance then cools off to consolidate and digest the recent gains. Then it’s rinse, wash and repeat. It looked like ASHR was going to do more than consolidate this winter but the recent rise in speculation that the PBoC will cut reserve requirements breathed new life in Chinese equities. For now ASHR is stuck in a trading range and consolidating recent gains and while the daily chart may not show overbought status, the weekly chart sure as heck does.

Europe:

So what about the Yinzer Analyst’s favorite investment, Europe, in 2014? While I still think the U.S. will stay the core of my own portfolio until proven otherwise, I think investors need to put more focus on diversifying their portfolios next year, especially with SPY up 15.45% annualized over the last five years versus 2.81% for the iShares MSCI EMU ETF (EZU) and 5.5% for the iShares MSCI EAFE ETF (EFA.) With such strong performance, why would anyone want to see “performance drag” from investing in anything other than U.S. equities? Performance catastrophes usually start off with logic like that.

So is the Yinzer Analyst still optimistic heading into year end? First on a weekly basis EZU has managed to get back above its summer downtrend line on better volume although it still has to challenge overhead resistance around $39.

EZU

What about compared to the S&P 500? On a daily basis, the relative momentum has been bottoming out for nearly two months now although EZU began weakening as it pushed towards the relationships’ 50 day moving average. On a weekly basis you can see that while the relative momentum hasn’t gotten any worse, it sure hasn’t gotten any better. Until it can break out of the downtrend line, domestic equities are still the “safer” bet in 2015.

EZU3

EZU2

Domestic Equities:

But what about domestic equities? Are they still the sure fire wager in 2015 that they have been five years into a bull market? Continuing to focus purely on technical, you can see that the S&P 500 has finally pushed above its consolidation range but did so on very weak holiday volume and giving us essentially a neutral CMF (20) score and a notable divergence from the price trend. Given the number of managers underperforming in 2014, I wouldn’t be surprised if the action stays quiet over the next few days with the market only showing a major trend change on Jan 2nd.

$SPX

But speaking of trend changes, the sector to watch continues to remain the healthcare sector. Despite the relatively weak price action in the second half of the week, XLV remains firmly entrenched in a relative momentum uptrend channel that formed in early 2012. The question remains whether the recent weakness in Gilead will be enough to derail the entire sector and send it lower in 2015.

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xlvrelmom

Setting up for another Defensive Rally in 2015

While everyone else may be off enjoying some holiday cheer, the Yinzer Analyst is still hard at work trying to help give you the edge in 2015…mostly because it’s a great way to avoid watching 3 hours of NCIS with the family. But while investors may be patting themselves on the back for sticking around to enjoy the low volume Santa Claus rally and all new daily highs of .3% moves, I’m starting to wonder if a deeper shift in sector leadership is forming that could portend great changes in 2015. While the FOMC induced rally was a nice Christmas surprise for many managers who expected only coal in their stockings, some of the early December sector trends are beginning to reassert themselves and could be signaling a shift back to the lower volatility sectors.

First, in the interest of full disclosure, I do write for another site, ETFG.com, and the topic I’m going to discuss is one I’ve written about there previously. ETFG does offer free trial subscriptions although you should be able to access the blog without one and I’d encourage all of you to check it out although I will be discussing new material I haven’t shared there. With that out of the way, let’s start by looking at some of the more obvious developments over the last few days:

First, China A-shares are finally seeing some profit taking on investigations by Chinese authorities into market manipulation. There’s a joke in there somewhere, it’s just too obvious to make:

SSEC

Energy stocks continue to show some signs of life, but have a ways to go before breaking the downtrend XLE has been stuck in for months:

xle

Probably the most significant development this week is that profit taking has finally come to the healthcare sector as XLV has given up nearly all of the post-FOMC gains as a slate of negative announcements about products in the FDA pipeline meets year-end profit taking. Healthcare stocks had a rough first half of 2014 before coming back to life as investors sought out higher volatility wagers, but today’s 2.3% drop broke the six month uptrend pattern and could signify more selling pressure to come although some way-too-early bottom feeding might keep them in the green tomorrow. What’s going to be more interesting in 2015 is that healthcare stocks are the third largest % of the S&P 500 and have nearly twice the weighting of energy stocks. Will healthcare weakness weigh that heavily on the market?

xlv1

So where are the profits taken from healthcare names being invested? There’s been a great deal of strong performance from the lower volatility sectors that help make up some of the more common low volatility “smart beta” ETF’s such as the iShares USA MSCI Minimum Volatility ETF (USMV). The phenomenon of low volume outperformance is nothing new and is one of the most demonstrated violations of the efficient market hypothesis so of course, someone slapped together an ETF to take advantage of this and all for a measly 15 bps a year. USMV has pulled in some SERIOUS cash this year and no surprise why, it’s up over 17.7% YTD compared to 14.9% for the S&P 500 Total Return and 11.7% for the average large blend mutual fund. But this success comes at a price; USMV and other low-beta ETF’s have been trading at record price multiples which have got the greats at the WSJ and FT wondering if you’re leaving yourself open to a low vol sell-off. Take a look at the chart below and you can see a major volume spike as investors took advantage of the FOMC rally to pick up USMV at a “slightly” lower price.

usmv

How did they generate such fantastic performance in 2014? Well yes, utilities were a part of that success but only a small part. For USMV, utilities make up about 8.5% of the allocation compared to the largest sector weighting with healthcare stocks at nearly 18% of the portfolio! Consumer Staples are #2 at 14% while 2014’s masters of “suckitude” energy stocks make up all of 5.7% of the allocation. So why do I go into this now? Well with healthcare stocks are trading at record levels and investors rightly concerned about profit taking, they’ve been casting their eyes at the other large components of USMV that haven’t participated nearly as much in 2014 and cutting out the middle man by investing in them directly to avoid the possibility to big losses after the multi-year run-up in healthcare stocks.

For USMV, the third largest sector holding is tech, with the largest weighting (6.6%) in companies on the services side such as Paychex, ADP and Visa as opposed to the largest positions in the Technology Select Sector SPDR Fund (XLK) like Apple or Google. I use the Vanguard IT VIPER as a better representation of low vol tech and you can see that as fears about the reality of rate hikes in 2014 set in this fall, VGT began making headway against the S&P 500 (using SPY) only to lose steam in mid-December when the “everyone in the pool” rally started on 12/16 and both VGT/XLK underperformed last week. Today it managed to get back above the uptrend line as reason returns after the initial joy starts to wear off (sort of like what happens after buying your wife a new car for Christmas.)

VGT

After tech stocks, the next largest USMV position is in the financial sector where high performing REIT’s are only around 3.4% of the allocation with insurance making up over 7.7% with the largest single holding being Chubb (CB) at over 1.3%. As you can see in the charts below; Financials (using XLF) and REIT’s (IYR) both lost steam versus the S&P 500 (REIT’s most noticeable in the late summer) as the sector leadership with the S&P began to change. Only with the breakdown of the energy sector in the fall do you see them begin to make ground with IYR breaking out of its momentum trade range while XLF begins to challenge it later in the year as the prospect for rate hikes becomes more realistic. In fact, financials underperformed last week not just on a pullback on low vol wagers but because the prospect for strong net interest margin growth seems more remote. One of the largest insurance sector ETF’s, the SPDR KBW Insurance Index (KIE), almost broke out of its momentum trading range versus SPY before the FOMC rally left low vol in the dust.

XLF

 REIT

KIE

In fact, if you look at this chart of utilities compared to the S&P 500 (xlu:spy) or USMV to SPY, you can see that a good portion of the mid-October rally was the contribution from low vol stocks pulling the S&P 500 higher almost against its own will given the weakness in energy stocks and the short-lived weakness against the high vol sectors last week is easing before year end.

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Again we have to wonder, will 2015 see another record year on a defensive rally?

Another Greek Drama and Making the Case for the Slow Horse

After a week like we’ve just had, with the S&P 500 pulling back 3.5% to close at its lows and almost given up the 2000 level, I bet you’re starting to think managing your equity allocation ahead of the year end isn’t such a bad idea after all. So where do you think the odds on favorites are going to be found in 2015? Given my known preference for increasing my European equity exposure in 2015, you’re starting to wonder just what the heck the Yinzer Analyst has been up to all week. Maybe spending too much time sampling the goods at our own local micro-distillery?

Why do I feel so optimistic about Europe? Did this week’s almost 5.5% pullback for the iShares MSCI EMU Index (EZU) ETF lower the damper on my fire? To be honest, this pullback helped ease my biggest concern about investing in Europe, that valuations were already sky high as investors anticipated the ECB’s upcoming QE program. First let’s look at the charts to breakdown this week’s price action.

First things first, let’s take a look at a chart of the most common ETF offering pure Greek-exposure, the Global FTSE Greece 20 ETF (GREK.)  Now study the chart carefully and tell me what you see.

GREKCould it be the fact that GREK has been steadily underperforming EZU since last spring?  From the high of June 6th to today, GREK is down 42.96% to the 14.72% loss for EZU.  Yeah, the chart above is the tame one but I like it because it shows the incredible volatility of GREK.  In fact, ETFG had it ranked on 12/5 with close to it’s highest short interest as a % of the free float and implied volatility in it’s history.  This thing, is to quote Gwen Stefani, bananas.  So the fact that Greece is a financial/market basket case is hardly news to anyone who’s been paying attention.

Now getting serious, let’s start off by checking out the hometown team using SPY as our proxy for domestic equity markets.  When I started this post on Thursday night I didn’t think we’d crack $202 so quickly if at all, but SPY plowed right through it late in the day to close just off the low on heavy volume with the price eliminating the divergence that had been forming with a steadily falling CMF (20) score since late November.

SPYIf you think that looks bad, avert your gaze from the drama in Europe where EZU also closed at the lows of the day, breaking through the support line around $37.75 and looking to challenge the downtrend line at $36.  The global risk-off trade didn’t help the situation, but the negative correlation with a rising FXE certainly did it’s part to pull a Harding on EZU.

EZUD

fxeThe situation looks no better on a weekly basis as the global rout signaled everyone holding a long position with a $38-$39 entry point from the fall of 2013 that it was time to take the money and run.  Having cracked the weekly downtrend line, the next likely stop is going to be at $35.75-$35.90.

EZUWeeklyWhat about relative momentum versus SPY?:

REL MOM WEKYou can see that for a brief period this week, EZU outperformed SPY to the point where it broke the downtrend line before concerns over the Greek contagion lead to a hard rout of European stocks. Try looking at the same chart on a daily basis.  You can see that try as it might, EZU can’t quite overcome the 50 day moving average.

50 DAYSo given the glum charts, why am I still so positive on Europe.  First it’s because despite the fact that Baron Rothschild never said anything about buying when there’s blood in the street, it’s still really really good advice to follow.  What do you think is the most important determinant to long-term returns?  It’s not technological growth or demographics or how quickly the money supply is growing, it’s the price you paid for the investment in the first place.

Ever since Draghi’s comments in early November about doing whatever it takes to expand the balance sheet, there’s been a steady stream of positive news reports from the ECB coupled with negative Eurozone economic developments that reinforce the need for additional monetary and fiscal actions to help combat a deflationary environment. The real question is whether the situation in Greece is significant enough to derail 2+ years of progress in combating the prolonged economic weakness Europe has endured. Honestly, doesn’t it feel like a story you’ve already heard before? Political uncertainty in Greece threatens existence of EU? Not quite as old as the Odyssey or even Oedipus Rex, but it has a familiar ring. My own theory is that all its done has been to shake out the weak hands (as much as I hate this expression) and restore valuations to a somewhat more attractive level. At the start of the week EZU has a trailing P/E multiple close to 18 and in the top decile of its prior trade history. According to ETFG the recent rout has pushed it’s valuations closer to historical median but I’d like to see a little more bleeding and improved momentum first.

Before you rush out to buy EZU or broader VGK, the latest Greek tragedy will play out over the rest of December which means that EZU could be retesting the $35-$37 range soon. But my investment thesis on Europe has more to do with long-term trends than technical or valuations.

The Case for the Slow Horse:

I’ve been of the opinion that the EU has been a slow-motion train wreck largely of its own making. Between an unwieldy monetary union, finance ministers who still think currency markets operate the way they did during the era of “golden fetters” and an obsession with debt-to-gdp ratio’s, Europe pretty much got everything wrong between 2008 and 2012. While heavily criticized at the time, the American decision to focus on saving the banking sector in 2009 to avert a loss of confidence following the forced mergers of 2008 proved to be the correct one. Thanks to Fed largesse and a change in mark-to-market accounting, the day of reckoning for American financial institutions was postponed until they were able to successful restructure their balance sheets and restore confidence that they were going concerns. Coupled with the American Recovery and Reinvestment Act of 2009 along with the on-going confidence lift from the QE programs, America was able to limp along until such time as it seemed that economic growth could be self-sustaining.

Contrast this with the situation in Europe where the response to the crisis was modeled on the Japanese approach of the last 20 years, incrementalism and subtly akin to Lyndon Johnson’s approach to Vietnam. Lacking a unified banking regulator, there was no consistent policy in place for backstopping weak financial institutions; instead the focus was on improving their financial condition by eliminating riskier debt and raising additional capital to comply with Basel III choking off what little lending there had been while doing nothing to address the concerns over their financial safety. Now European financial institutions are very well-capitalized, but with low loan demand and no prospect for NIM growth. And without a federal structure, the EU had no ability to effectively deliver stimulus aid where it was needed to resolve fiscal in balances instead forcing highly indebted EU nations to raise taxes and cut spending, the exact opposite of the Keynesian response typically employed during a recession.

As anticipated, economic growth weakened to nothing raising the specter of default, increasing volatility and forcing EU financial institutions to unload supposedly safe sovereign debt, igniting the Euro Bond Crisis of 2012. Only the addition of “Say Anything” Draghi as the head of the European Central Bank and the realization by German politicians of how close to the brink they were helped ease tensions within the Eurozone while also simultaneously restoring confidence. From the low point of the Eurocrisis in 2012 to the this summer, the iShares MSCI EMU index performed in line with the S&P 500.

So why am I taking the time now to dredge up what in this day is considered to be ancient history? Because the policy differences between the U.S. and Europe are set to become even more extreme and this time, the Europeans might be the ones with the better hand to play and that differential could mean all the difference for expected returns going forward.

We don’t need to sit down and derive the Kalecki-Levy profit equation from Macroeconomics 1 to understand that one of the biggest drivers of corporate profits over the last five years has been the Federal budget deficit. Although the steady decline in government hiring and spending has been acting as a drag when figured into GDP calculations, government spending has been a major boost to the economic recovery despite what you might hear on Fox News. Even though there are no truly “closed” economies, remember that government spending becomes private saving so government deficits are a source of revenue to the private sector while the federal surpluses of the late 1990’s withdrew capital from the economy. In fact, the on-going fight over federal spending and the infamous sequestration battle of 20XX were cited by Ben Bernanke as one of the reasons for Quantitative Easing in the first place even though he knew that loose monetary policy could only do so much to counteract fiscal tightening.

How this pertains to our current situation is that even with the recent swap in Congressional leadership, U.S. fiscal deficits are projected to remain fairly narrow at 3% or less of GDP for the next decade, removing a potent source for corporate profit growth. And while they may have narrowed substantially over the years, another source for profit growth, personal savings, is already close to historic lows. In 2012, personal savings bounced back above 7% before running even higher into the end of the year as companies rushed out special dividends ahead of the change in legislation from Bush-era on lower dividend tax rates. Since then, personal savings rates have hovered between a low of 4.1% to 5.3% (October was 5%) offering little hope of further profit stimulus from this quarter.

This leaves dividends and investments to help generate the profit growth necessary for the S&P to continue advancing but with dividend payouts and share buybacks already running at 95% (or over 100% depending on the source) of trailing earnings, there’s little room left for further growth unless earnings accelerate or more debt is added to finance them. But then what capital is available for further investments? Real gross private domestic investment is already running around a 4.9% year-over-year rate of change and while that’s above the 2% lows from late 2012 and early 2013, it’s down from the 8.7% level of 4Q 2013. That only leaves net exports and with a rising dollar and falling oil prices/falling oil demand, what’s the outlook for U.S. exports except for passenger jets and military equipment?

So does that mean there’s going to be zero profit growth in the immediate future? Not at all, if just means that any growth will be more limited for the immediate future. At the close of 2013, analysts surveyed by S&P estimated 2014’s earnings would grow nearly 28%, by 9/30/14 there were estimating instead they would grow 21%. So far, the 3Q/13 to 3Q/14 growth rate has been 12.3% with Factset reporting expectations for 4Q are already declined to 3%. If earnings growth does come in that low, the full 2014 earnings for the year will be less than 9%. Depending on where we close, it’s possible than 100% of the full years return will be driven by earnings growth rather than multiple growth. Where does that leave 2015? If the trailing multiple were simple to go from the current 19.5 to 17 and earnings grow 10%, we’re nearly fully valued for 2015.

European Contrasts:

And is Europe in such a vastly better condition you ask? No, but their position in the business or sentiment cycle is much better than ours. From my point of view:

  1. ECB Commitment to Expanding the Balance Sheet: This is the key, they’ve already agreed to a $1 trillion expansion and I agree with Andrew Smithers at FT, this isn’t nearly enough. Does that mean it’ll fail? No, they will just have to keep committing to more and more programs until it works. Sound familiar? If they did just that, it would be QE 2 and QE 3 all over again.
  2. Euro Destruction: The Euro has already moved south to the tune of 10.4% since May 5th and while the Greek anxiety has some covering short Euro positions waiting for the inevitable announcement of a new backstop to send it higher, any move to expand their balance sheet while the Fed stops expanding theirs could send the Euro lower. Besides improving the short-term Euro outlook, it acts as a major boost on corporate earnings. A Reuters piece on September 5th estimated that the then 5% drop in the Euro could lift corporate earnings 3%-6%.
  3. Loosening up the belt: After years of cutting spending and raising taxes, Eurozone leaders seem to be coming to grasp with the idea that they only way they can maintain target debt-to-GDP ratio’s is to focus on growing GDP and not Germany’s fixation on belt tightening. Never having reached the deficit depths descended to by the U.S., the Eurozone aggregate deficit in 2013 was only 2.9% with only France and Spain exceeding that average for the year. While government finances are relatively stable, the on-going tepid growth of the Eurozone, when contrasted either with the U.S. or the EU nations with a free-floating currency is astounding. While it’s irresponsible to think that this will change overnight, the recent discussions of new infrastructure and stimulus funds is a marked change from the recent past either in Europe or the U.S.

So if you were to ask me why, when presented with the choice of a long-time winner that looks a little sluggish and at terrible odds or a perennially also-ran that’s fighting the trainer and offering better payouts, why wouldn’t I take that bet?

Want to Guarantee A Comfortable Retirement? Marry a Nurse.

One of the most common lessons in investing is the need for portfolio diversification, to use assets with low correlations to reduce the volatility of a portfolio which might sacrifice some potential return in the short-term while providing for higher long-term returns by reducing draw-downs during equity pullbacks. It’s the first lesson taught in investing 101 and is so thoroughly incorporated into the language of financial professionals that it’s probably the only thing that literally everyone in the industry can agree on. But diversifying your investments is only part of the process so gather around for story time.

When I was in grad school, I took a capstone course that meet on Friday afternoons and ran for three hours so needless to say, it wasn’t particular well attended despite the fact the professor was fairly well known, the former dean of our business school and played tennis with a soon to be Fed Chairman from Princeton. One day not long before the end of the semester, the professor turned to the room and said to us, “I’m going to tell you how to make a fortune and live a comfortable retirement.” Well that managed to drag us out of our afternoon siestas and we looked onto eagerly, waiting for this bit of wisdom that could provide us with the wealth we needed to insure that we would never actually to use anything else we had learned there. Seeing our eagerness, he walked away from the board and in a perfectly flat voice said, “You want to enjoy your retirement? Marry a nurse.”

Saying we were stunned would be an understatement. Was this why we had sacrificed so many Friday afternoons when we could be making an early start of our weekends? But then he said, “Let me finish. You’re all going to work in finance or accounting when you leave here and I can guarantee that no matter how smart you are or how hard you work one day, the market will turn or your division will have a bad quarter. When that happens, you’ll be laid off. It happens to everyone, it’s part of the business and how the game is played.”

“So what happens then? The market pulls back and you’re laid-off. Well guess what, it’s worse than you thought because so much of your compensation is deferred in the stock of your employer and that’ll be losing value too…just when you need it the most (ask anyone who worked at Lehman about that.) And because you work in finance and think you know better than everyone else, your portfolio is 100% stock so what do you think is happening there?”

“Remember, your portfolio consists of two assets; the financial capital you’ve accumulated till now and your human capital that will be earned in the future. For most of you in this room, you have no financial capital but that doesn’t matter because the most important asset in your life is yourself; the knowledge you gained here will help you make more money when you graduate. From that higher starting point, you’ll earn more over the course of your working life and if you discount it back to today, the present value of those future earnings has increased dramatically. As you work and the years go by, the value of your human capital will begin to fall but your financial capital, everything you’ve saved and invested will grow and compound over time until you reach retirement. Then your human capital will be close to zero and your financial capital will have to meet the bills so you buy bonds, leave some in cash, put a little in stocks and hope you get that 4% real return to see you through.”

“So how can you protect your financial capital when you hit a rough patch in your professional life…marry someone in a completely different industry. My wife is a nurse, but who cares? Marry a teacher, lawyer, cop, just don’t marry someone in the business. Think about it; you marry a mortgage broker for Countrywide (don’t judge me, it was the mid-2000’s) and you both get laid-off during a pullback…what happens then? How are you going to make ends meet besides raiding your financial portfolio while the value of your human capital is falling? You’ll work again, but those future earnings will be lower and you’ll have less financial capital today to help plan for tomorrow.”

Marry someone who’s job isn’t dependent on whether stocks are rising or falling. It’s the ultimate portfolio diversification. When you stumble, they can be there to catch you and keep you (and your human capital) from falling and you’ll do the same for them someday.”

Remember, the most important asset in your portfolio is YOU so how can you better yourself to improve your earnings today and provide for tomorrow? So to all my readers I leave you with this; do you want to have a comfortable retirement playing golf or does your retirement plan consist mostly of “tender vittles?”