The Charts Speak For Themselves
The Charts Speak For Themselves
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Charts Monitor, Rather Than Dismiss Fundamental Data
Critics of technical analysis often mistakenly believe that using charts discounts the importance of fundamental data, such as earnings, employment, and economic growth. Charts allow investors to monitor the aggregate investor interpretation of all the fundamental data. Said another way, charts are efficient tools used to monitor vast amounts of fundamental data, which is important since fundamentals ultimately determine which assets classes will perform best. When the economy is healthy, stocks tend to beat bonds. When economic fear dominates, bonds tend to beat stocks. In this article, we will cover the latest signal from the markets that came on February 11, 2016.
Dow Theory Is Based On Economic Common Sense
Dow Theory is based on a series of Wall Street Journal articles written by Charles Dow. The basic tenets of Dow Theory are easy to understand. Charles Dow believed that:
Behind The Averages
After reviewing the companies in the industrial and transportation averages, it is easy to see why they represent logical vehicles to monitor the pulse of the U.S. economy. I the present day, our economy is driven by more than just industrial or manufacturing companies. The Dow Jones Industrial Average contains traditional producers, such as IBM (IBM), 3M (MMM), Boeing (BA), Chevron (CVX), and Johnson & Johnson (JNJ). However, the Dow (DIA) also contains Visa (V), Goldman Sachs (GS), and American Express (AXP), since the present day economy relies heavily on the financial sector. The Dow Jones Transportation Average (IYT) still has railroads, such as Union Pacific (UNP) and Norfolk Southern (NSC), but it also contains more modern logistics companies, such as United Parcel Service (UPS), Fed-Ex (FDX), and J.B. Hunt (JBHT).
Just Reconfirmed Primary Bear Market
If investors believe industrial and transportation stocks are starting to become less desirable that speaks to their conviction to own these key sectors vs. their conviction to sell. When aggregate bearish conviction starts to outweigh aggregate bullish conviction, stock prices start to fall, which is also a reflection of investors’ perception regarding future economic outcomes. The Dow Jones Industrial Average posted a new closing low on Thursday, February 11, 2016.
Similarly, the Dow Jones Transportation Average also posted a new closing low in December of last year. These lows are the basis for a new Dow Theory primary bear market confirmation signal.
Investment Implications - The Weight Of The Evidence
Our market model does not use Dow Theory, but it does use numerous inputs based on the Dow Jones Industrial Average. As noted in early January, the evidence has been saying “It Is A Good Time To Check Your Bear Market Game Plan”. The Dow Theory signal that occurred on February 11 is another form of evidence saying the same thing. We continue to be concerned about the set-ups described on February 5. Conditions can begin to improve at any time, but until they do our allocations will continue to favor conservative assets (TLT) over growth-oriented assets (SPY).
Myth Busters – Dividend Stocks Are Safe
In recent years, many investors have been attracted to the “safety” and “wealth-building” appeal of dividend stocks. Therefore, it is prudent to examine history and ask:
Will my net worth take a big hit holding blue-chip dividend payers in the next bear market?
Before we explore the facts, it is important to understand that well-intentioned investors have a habit of repeating the same mistakes over and over again. If we understand the propensity to make mistakes, it is more likely we can reduce the odds of taking a hard-to-recover-from blow to our retirement nest egg and/or estate. Is it a mistake to think of dividend stocks as safe? You can decide after reviewing the evidence.
Dividend Investors Making A Common Mistake
Why did we have a tulip bulb mania in the 1660s, a dot-com bubble in the 1990s, and a housing bubble in the late 2000s? The human emotions of greed and fear have not changed the last 400 years. To refresh our memories, a quick read of the segment below from an April 2000 BusinessWeek article is in order:
Around 1624, the Amsterdam man who owned the only dozen specimens was offered 3,000 guilders for one bulb. While there’s no accurate way to render that in today’s greenbacks, the sum was roughly equal to the annual income of a wealthy merchant. In recent years, as investors have intentionally forgotten everything they learned in Investing 101 in order to load up on unproved, unprofitable dot-com issues, tulip mania has been invoked frequently.
Just The Facts Ma’am
Rather than pontificate about the pros and cons of holding dividend stocks, it is best to focus on their actual performance. Our intent here is not to criticize any article or piece of well-intentioned investment research, but rather to educate investors about the downside risks associated with a buy-and-hold strategy in “safe and reliable” dividend paying stocks.
The 10 Most Popular High-Yielding Dividend Stocks
Our first list of dividend payers was compiled based on the concern that a stock market correction is overdue. The list includes Unilever (UN), General Electric (GE), ConocoPhillips (COP), Vodafone (VOD), Johnson & Johnson (JNJ), Sysco (SYY), Pfizer (PFE), Merck (MRK), Eli Lilly (LLY), and Glaxo SmithKline (GSK). Corrections are followed by rallies to new highs. Therefore, a buy-and-hold strategy can work well during a normal market correction. However, the real test of wealth preservation comes in a bear market. The blurb below from The Street describes the list of 10 stocks that follows:
Concerns that a stock market correction is overdue may be turning investors, particularly those near or in retirement, into yield hounds… In addressing that interest, ratings and research firm Morningstar, which tracks the portfolio changes of 26 top-performing mutual funds for its “Ultimate Stock-Pickers” series, screened its funds list. It found the most dividend-focused funds with stocks that pay an annual yield greater than that of the S&P 500’s 2% for last year…Here are the 10 most popular high-yielding dividend stocks among Morningstar’s Ultimate Stock-Pickers funds, listed in inverse order of highest yield.
How would we have done in the last bear market with these 10 stocks using a buy-and-hold approach? The table below shows the closing prices for each stock at the bull market peak, October 9, 2007, and the bear market bottom, March 9, 2009.
But, 2007-2009 Was A Rare Period, Right?
Yes and no; all bear markets are brutal and they have their own unique set of negative fundamental factors. However, let’s assume the 2007-2009 financial crisis was a rare period or a period much different than today. If so, we would expect “safe” dividend stocks to be holding up well since the S&P 500 peaked on May 21, 2015. As shown in the table below, the average loss for the same ten dividend stocks is 8.87% since the S&P 500 peaked.
A False Sense Of Security
Our next list of dividend payers comes from a July 2013 article on Yahoo Finance:
So, what’s the appeal? For one: security. A blue-chip stock gives you equity in a large, reputable and financially sound company with a long history. Their stocks are attractive not only because of their familiarity, but because they tend to be less volatile and have a record of paying stable or rising dividends (read: extra money in your pocket) for years, if not decades…we’ve highlighted 10 popular, widely held stocks.
The list includes McDonald’s (MCD), Coca-Cola (KO), Wal-Mart (WMT), General Electric (GE), Procter & Gamble (PG), Microsoft (MSFT), AT&T (T), Walt Disney (DIS), Wells Fargo (WFC), and Johnson & Johnson (JNJ). We have to give the author some credit; she did point out that “all investing comes with risk and blue-chip stocks can still lose significant value.” The performance of the ten stocks during the last financial crisis illustrates the real world risks associated with any buy-and-hold investment approach.
How About A Data-Based Stock Screen?
The list below shows the performance of the “Top Rated Dividend Paying Stocks” on Dividata.com; it includes Monmouth Real Estate (MNR), Landauer (LDR), Leggett & Platt (LEG), Universal (UVV), Courier (CRRC), Kinder Morgan (KMP), Universal Health (UHT), HCP (HCP), Hawaiian Electric (HE), and Mercury General (MCY).
Help You Navigate To Retirement?
The list below was referenced as a way to “navigate” to retirement; it includes Kimberly-Clark (KMB), Johnson & Johnson (JNJ), McDonald’s (MCD), Chevron (CVX), and HCP (HCP). Can you imagine if you lost 34% the year before you were due to retire?
Good Dividend Payers To Buy On Dips
This list below is comprised of common dividend names that have been written about in recent months as potential buy candidates for blue-chip investors. The list includes International Business Machines (IBM), Target (TGT), Mattel (MAT), Aflac (AFL), Aqua America (WTR), Ford (F), Bristol-Myers (BMY), Consumer Staples ETF (XLP), Altria Group (MO), General Mills (GIS), Kimberly-Clark (KMB), Pepsico (PEP), Clorox (CLX), Health Care ETF (XLV), Johnson & Johnson (JNJ), Merck (MRK), Baxter International (BAX), and Owens & Minor (OMI). The average loss during the last bear market for these stocks was over 36%.
Safe Stocks For A Market ‘Storm’
The last list was published on Forbes.com with the title “12 Safe Dividend Stocks For The Market Storm”. The list includes Reynolds America (RAI), Coca-Cola (KO), Southern Copper (SCCO), Eli Lilly (LLY), H&R Block (HRB), Leggett & Platt (LEG), Lockheed Martin (LMT), Paychex (PAYX), Pearson (PSO), Cinemark (CNK), STMicroelectronics (STM), and United Parcel Service (UPS). These safe haven dividend payers lost 47% during the last bear market.
Are Dividend Strategies Useful?
Dividend strategies can be very useful and add value for investors. The hole in some of these dividend strategies is they focus exclusively on when to buy. As noted on Twitter, when to buy is important, but it is less than half the investment battle.
Adding Risk Management To The Equation
An investment game plan that does not include an exit or a risk-reduction strategy leaves the investor open to hard-to-recover-from losses. The previous statement applies to any dividend-based investment approach. There are 54 different dividend stocks shown in the lists above. The table below shows the performance of the 54 stocks between October 9, 2007 and March 9, 2009. Since the share prices are adjusted for dividends, the figures below account for income payments, which shows dividends will not save an investor in a bear market.
More on prices that are adjusted for dividends From Yahoo Finance:
Adjusted Close provides the closing price for the requested day, week, or month, adjusted for all applicable splits and dividend distributions. Data is adjusted using appropriate split and dividend multipliers, adhering to Center for Research in Security Prices (CRSP) standards.
Investopedia expands on the benefit of using adjusted closing prices, as we did in this analysis:
The adjusted closing price is a useful tool when examining historical returns because it gives analysts an accurate representation of the firm’s equity value beyond the simple market price. It accounts for all corporate actions such as stock splits, dividends/distributions and rights offerings.
Was The Financial Crisis Unique?
No, the S&P 500 lost over 50% in both the dot-com bear market and the financial crisis bear market. As shown in the chart below, three years of stock market gains were wiped out in the 2000-2002 bear market.
Of the 54 stocks studied above, 53 of them were in existence during the dot-com bust. The blue-chip heavy Dow Jones Industrial Average (Dow) peaked on January 14, 2000. The Dow found a bottom on October 9, 2002. Over that period, some dividend stocks added significant value. However, 66% of the 53 dividend paying stocks lost money during the 2000-2002 bear market. Of those 66%, the average loss was 13.58% (based on adjusted closing prices).
Is There Anything Investors Can Do?
While there is no magic investing bullet, there are things that investors can do to mitigate (not eliminate) risk during a bear market. It is important that any investment strategy have a “when to prudently buy” and a “when to prudently sell or reduce risk” component. Risk management topics that can be paired with any stock-based strategy have been covered numerous times in the past, including in the articles listed below:
DRIPS Are Buy And Hold
Another often recommended way to invest in dividend stocks is via dividend reinvestment plans or DRIPS. DRIPS have many benefits (low cost, disciplined, consistent), but they also are a form of buy-and-hold unless paired with some type of risk management strategy. Therefore, DRIPS are not a fool proof method for wealth preservation during a bear market. If the returns for dividend stocks during bear markets shown above are concerning, then DRIPS are concerning as well.
Benefits Of Dividend And Blue Chip Investing
All stocks carry risk, including blue-chip dividend stocks. Having said that there are numerous benefits to investing in blue-chippers, such as consistent dividends, established brands, top-tier management, access to DRIPS, and in some cases, substantially lower volatility relative to the broad stock market. If we understand the pros and cons of any investment option, we are more likely to make better risk management decisions.
Defensive Assets Strong Early In Week
When investors are fearful, common sense tells us demand picks up for more conservative assets, which is exactly what happened early Monday morning. From Bloomberg:
“Signs of distress in financial markets are gathering force as concern over the state of the global economy deepens. The Standard & Poor’s 500 Index declined as much as 2.2 percent, as U.S. shares joined a retreat in European and emerging-market stocks. Investors sought the safest assets, sending yields on Treasury 10-year notes to the lowest level in a year, and those on Germany’s 10-year bunds to the lowest since April. Meanwhile, yields on bonds of Europe’s most-indebted countries rose, while the cost of protecting against default by U.S. junk-rated companies climbed to the highest since 2012.”
Red Flags In 2008
If you felt the economic outlook was uncertain and you wanted a relatively high degree of safety of principal, what investment might be appealing? Bonds with longer maturities that lock in rates and have a low probability of default, which sounds a lot like long-term U.S. Treasuries (TLT). When investors are very pessimistic and fearful, return of principal becomes highly important. Therefore, when fear increases we would expect to see defensive bonds outperform growth-oriented stocks. That is exactly what started to happen in a fairly convincing manner in late June 2007, when the S&P 500 was trading at 1,310. After the warning from bonds, the S&P 500 dropped an additional 42%.
What Is The Ratio Telling Us Today?
The recent spike in the demand for Treasuries relative to the demand for SPY aligns with the bigger picture concerns outlined in this week’s stock market video (below chart).
Investment Implications - The Weight of The Evidence
This week’s stocks market video, recorded on Friday, February 5, covers the rationale for putting stocks on a “plunge watch” until conditions improve.
Since early December 2015, our market model has added to conservative positions (IEF), and significantly reduced exposure to stocks (VOO). We are happy to reverse that process when the hard evidence begins to improve.
You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.
You Can Draw Your Own Conclusions About Risk vs. Reward
Charts Provide An Unbiased Reference Point
One of the great things about stock charts is they allow us to track the markets using reference points from the past. For example, we may have drawn a trendline three weeks ago, then three weeks later the market rallies back to the trendline and reverses. Therefore, in today’s post we are going to republish a previous post, but with updated charts as of February 3, 2016. The updated charts alllow us to ask:
Have the charts improved in terms of looking more like the bullish turn in 1994?
The original post, “Do The Bulls Have Any Reason For Hope?”, was dated Jan 12, 2016. The same post appears below with updated charts.
Flexibility: An Ally In Markets
We recently outlined numerous concerns about the sustainability of the current bull market in stocks. Experience tells us that thinking we know what the future looks like is a big mistake. If you are skeptical about the previous statement, look at the track record for economic and market forecasts; it is not good. Therefore, under our approach we allocate our portfolios based on facts.
Since market profiles can improve when new facts come to light (see March 2009), it is important for us to keep an open mind about all future outcomes (bullish and bearish).
Markets Are Always Dealing With Good And Bad News
Markets and charts always reflect the net balance between good news and bad news. Bear markets start when the net balance shifts to the bad side of the ledger. The previous statements can be applied to any year with any mix of good and bad news.
Historical “Open Mind” Case
Given the 2016 market profile is concerning, it is logical to ask:
Have stocks ever rallied from a similar good news vs. bad news profile?
The answer is yes, in 1994-1995. Before you say, but today is different, keep in mind the market was dealing with good and bad news in 1994, just as it is today. The charts in 1994 reflected the net interpretation of all the good news and all the bad news.
Trends Reflect The Net Aggregate Opinion
One way to keep an eye on the market’s net interpretation is to look at market trends. When trends are bullish, it tells us the net interpretation is positive relative to future expectations. When trends are bearish, it tells us the net interpretation is indicative of concerns about future outcomes. The two weekly charts below show trends (the net interpretation of all fundamental data) in late 1994 are similar to trends in early 2016. There is nothing magical about the 25, 50, or 100-week moving average; we could have used the 50-day and 200-day or any number of technical methods.
From A Similar Profile, Some Improvement Took Place
In 1995, when good things started to happen, the improvement started to show up on the chart (see below). Notice how the slopes of the 25-week (blue) and 50-week (red) flipped from negative to positive. In 2016, the slopes of the 25-week and 50-week remain negative. If the S&P 500 rallies in 2016 and the slopes of the 25-week and 50-week turn back up, it will improve the odds of good things happening.
What Happened Next In 1995?
Stocks did very well tacking on an additional 41% of gains between early 1995 and mid-1996.
Important Point: No Improvement Yet In 2016
For the 1994 analogy to remain alive, the 2016 S&P 500 chart needs to show improvement; something that has not happened yet. The present day profile continues to reflect a net concern about future outcomes, similar to periods in 2007-2008 and 2000-2001.
The Historical Cases Can Help Either Way
Can the 1994 case help us with bearish odds? Yes. If the 2016 chart starts to deviate from the 1994 analogy, it speaks to increasing bearish odds. For example, the 2011 analogy worked very well in 2015, as clearly demonstrated here. However, the 2011 analogy appears to be breaking down in 2016 (as outlined here), which speaks to increasing odds of bad things happening. The keys in 2016:
Our purpose here is not to say the market’s profile will or will not improve in 2016, but rather to point out that history says things can improve from a similar net aggregate interpretation of all the good news and all the bad news. The bulls are on the ropes, but the ten count has not been given yet.
Is The Third Market Myth About To Be Exposed?
This week’s stock market video looks at three investing myths. Two of the myths have been taken off the table; the third remains. What could happen when the third market myth falls?
Fed Speaker Monday
After last week’s Fed statement, the market will be looking for some additional insight when Fed Vice Chairman Stanley Fischer speaks Monday. From MarketWatch:
It is likely to be standing room only at the Council on Foreign Relations on Monday as the market strains to hear Fed Vice Chairman Stanley Fischer’s latest views on the economy and interest-rate policy. “Obviously Fischer is going to get a fair bit of attention, coming so soon after the January statement and with a fair bit of question of what they meant,” said Michael Hanson, economist at Bank of America Merrill Lynch.
The Most Important Story Of Our Investment Lifetimes
This week’s video features the “three legs of the stool” story. The story focuses on three market myths and the impact on the psychology of global financial markets.
Investment Implications - The Weight Of The Evidence
Given the damage done to the market’s risk-reward profile in January, it is too early to determine the significance of Friday’s big rally in stocks.
The charts below show similar points during the dot-com bear market and financial crisis bear market. Takeaway number one is each bear market (or correction) is unique. Takeaway number two is not too many good things happen when the 50-day (blue) is below the 200-day (red) and the S&P 500 is below both moving averages. In the 2000-2001 example, stocks did not find a bottom for another 18 months. In the 2007-2008 case, stocks remained in a downtrend for an additional 9 months.
As noted in this week’s video, ugly looking market profiles can begin to improve at any time, which means it pays to remain highly flexible and open to all market outcomes (bullish and bearish). Given what we know today, cash, some currencies, and bonds (IEF) continue to offer a better longer-term risk-reward profile relative to stocks (SPY).
The Most Important Story Of Our Investment Lifetimes