S&P 500 and the 2016 January effect

The statement "As January goes, so goes the year" has some merit as January stock market returns have been proven as a decent leading indicator for whole year returns. January 2016 ended with a 5.07 % negative return.

The probability for a negative full year return in the S&P 500 if January ends in the red is 57 % vs. 31 % unconditionally. These are the years where the S&P 500 went through the worst starts to January and their corresponding January returns and full year performance:

Year            Jan perf        Full yr. perf

2009            -8.57 %             23.45 %

1970            -7.65 %               0.10 %

1960            -7.15 %              -2.97 %

1990            -6.88 %              -6.65 %

1939            -6.39 %              -5.18 %

1978            -6.15 %               1.06 %

2008            -6.12 %            -38.49 %

2000            -5.09 %            -10.14 %

2016            -5.07 %                ??? %

1977            -5.05 %            -11.50 %

For the above sample of worst starts to January years excluding 2016 the average February to December return was 1.18 % and the average full year return was negative 5.58 %. This may indicate that it is probable that 2016 will not be a great year for US equities.

On the other hand we have seen recent poor S&P 500 January performance turning into great bull years as well:

Year            Jan perf        Full yr. perf

2009            -8.57 %             23.45 %

2003            -2.74 %             26.38 %

2010            -3.82 %             12.78 %

January return vs. full year return for the S&P 500:

                              Source: Haver Analytics and Yardeni Research Inc.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Reevaluating Emerging Markets

As previously discussed I find Emerging Markets ("EM") equities to be cheap compared to developed world equities and compared to historic pricing multiples: Oeistein Helle: The time to buy emerging markets may be now

My initial EM strategy was to go long a MSCI Emerging Markets index ETF. The index is heavily weighted towards the MSCI China Index and China´s closest trading partners such as Korea (South), Taiwan and Brazil (graph #1 depicts EM countries by percentage of exports to China).

Although both the MSCI China Index and China´s closest trading partners equity markets look cheap on a fundamental basis these markets may experience negative shocks from China´s economic transition into a modern consumer based economy. Furthermore China´s closest trading partners currencies will most likely depreciate significantly alongside China´s planned currency devaluation scheme. Such currency depreciation may be positive for the trading partners in the short-term as it may increase exports (graph #2 depicts EM countries by short-term GDP growth sensitivity to a 10 % devaluation of the Chinese currency). However in the mid- to long-term I suspect countries dependent on exports to China will go through a painful transition.

Overall EM is cheap on both a local currency basis and USD basis, however I want to decrease my overall exposure to a potential Chinese black swan. Goldman Sachs stated in a 2016 - 2020 forecast that "Chinese stocks could see a downdraft similar to Japan's 1990s post-bubble tumble. That could leave mainland equities with a 7-8 percent a year decline over the period". I will sell my MSCI EM index ETF and be more selective in my EM exposure going forward.

I have gathered data covering the twelve most important EM countries excluding China and made an investable index based on three criteria: Valuation (graph #3), percentage of exports to China (graph #1) and 2016E real economic growth (graph #4). The valuation measure is based on annual expected real return from 10Y Shiller P/E reversion in local currency and the current dividend yield. The three criteria have equal weight and each country receives a score between 1 - 12 where 12 is the best score for each of the three criteria.

The four countries that received the best total scores were Poland, Turkey, India, and Russia according to the investable index (graph #5). I will not invest in India as India´s current valuation is stretched. I will invest in ETF´s reflecting the equity markets of Russia, Poland and Turkey, where I will overweight Russia as I am a strong believer in an improved oil price in the mid- to long-term: Oeistein Helle: Stein´s law makes me 99 % certain that the oil price will bounce back in the mid- to long-term

Graph #1: Percentage of total exports to China

                                 Source: International Monetary Fund


Graph #2: Short-term GDP growth sensitivity to a 10 % devaluation of the Chinese currency

                              Source: Oxford Economics


Graph #3: 10Y expected local currency real return derived from Shiller P/E and dividend yield

                                 Source: Research Affiliates LLC. 


Graph #4: 2016E real GDP growth

                                 Source: International Monetary Fund

Graph #5: Final EM investable index

                                 Source: Oeistein Helle

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I am planning on going long MSCI Poland/ Turkey/ India/ Russia ETF´s.

S&P 500 Shiller P/E and beyond

As you may know the Shiller P/E or CAPE ratio is a valuation measure which divides a stock price or an index price by its 10 year average earnings per share or earnings per unit. The Shiller P/E measure enables the analyst to view the price-to-earnings relationship in a complete business cycle context. The Shiller P/E measure has been proven useful in order to evaluate under or over appreciated sectors or markets. If a market´s multiple as represented by an index is far above its historical median, a reversion to the median may occur over time. An overvalued index may yield poor average performance the next ten years. All below data has been gathered from Research Affiliates LLC. and is of 31 December 2015. 

US large cap stocks as represented by the S&P 500 index currently has a 26x Shiller P/E vs. its historic median of 16x. In terms of the Shiller P/E measure the S&P 500 index valuation is stretched. US small cap stocks as represented by the Russel 2000 index currently has a 46x Shiller P/E vs. its historic median of 40x. In terms of the Shiller P/E measure the Russel 2000 index valuation is close to its historic median. 

US large and small cap stocks current Shiller P/E vs historic median:

                                          Source: Research Affiliates LLC.

First of all, do not pay too much attention to the net of inflation expected return calculated by Research Affiliates Inc. as the expected return is based on the reversion of the Shiller P/E measure and a 10 year forecast of both economic growth and dividend growth. Do not fully trust 10 year forecasts as the future is more random than what analysts are willing to admit. 

Although US large cap stocks as represented by the S&P 500 looks expensive from a Shille P/E standpoint one may argue that the current pricing is in equilibrium:

• The recent S&P 500 correction has slightly improved the index Shiller P/E
• The forward S&P 500 P/E multiple is currently close to its 20 year average
• The index data dates back as far as 1871. One may wonder if 19th century asset pricing is relevant today. I am quite sure that the current S&P 500 Shiller P/E would look less stretched if compared to the last 25 years median 
• Current risk-free interest rates are low. If you remember CAPM from school such low rates support higher valuation multiples as low interest rates decrease the discount rate applied to future cash-flows in DCF valuations
• The S&P 500 index is less volatile than many other comparable international indexes
• Compared to its historic median the S&P 500´s Shiller P/E is skewed as the measure includes depressed financial crisis earnings 

As an alternative to US stocks you may want to take a look at the below mentioned emerging markets which currently are priced at or close to the minimum of their historic Shiller P/E ranges. Note that the data is based on USD inputs. Keep in mind that some of these Shiller P/E´s are supported by shorter data time-series, resulting in less reliable Shiller P/E measures. Furthermore some of these markets are changing rapidly which may result in an even less reliable Shiller P/E measures. Some of these economies are currently in trouble and you need to be a believer in cyclical rebounds in order to find them investable. However if you are a contrarian like I am you should definitely take a second look at these:

Selected emerging markets Shiller P/E vs historic median:

                                Source: Research Affiliates LLC.

• Brazil is represented by: MSCI Brazil index
• China is represented by: MSCI China index
• India is represented by: MSCI India index
• Malaysia is represented by: MSCI Malaysia index 
• Poland is represented by: MSCI Poland index
• Russia is represented by: MSCI Russia index
• South Korea is represented by: MSCI South Korea index
• EM Equity is represented by: MSCI Emerging Markets index

Disclosure: I am long MSCI Emerging Markets UCITS ETF (acc).

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Do not panic!

• Russel 2000 is down by 25 % from its 2015 high 
• FTSE 100 is down by 19 % from its 2015 high 
• Nikkei is down 21 % from its 2015 high 
• Shanghai is down 40 % from its 2015 high 
• Oil is down by 70 % from its 2014 high 

There is no doubt that we are currently experiencing a global bear market in equities and commodities. However I do not believe this is a 2007 - 2008 type of cataclysmic once in a lifetime market crash. This is why: Oeistein Helle: Ongoing S&P 500 correction not like 1973, 2000 or 2007

I know they are telling you that low oil prices somehow will result in a recession in the US and in Europe. This does not make any sense as low oil prices are good for most of the global economy including the USA, Western Europe, China, India and Japan. I also know that they are telling you that this is all China´s fault, a country experiencing growth inline with expectations. Furthermore China is not an important export market for the USA which accounts for 5 % - 7 % of the S&P 500 companies revenues.

Corrections and bear markets in equities may occur for no good reason at all, they just happen unexpectedly and violently. If you are not up for annual 10 % corrections, semiannual 20 % bear markets or 30 % or more equity devaluations a couple of times each decade you should not be in stocks. I do not live in Florida anymore, however the stock market is a good alternative to Disneyworld´s wild rides.

Do not panic and do not sell everything. Rebalance and pick up assets as they reach your pricing thresholds. Fun fact: This is the 34th S&P 500 correction since 1950. 

GDP and oil price with negative correlation, GDP increases when oil prices are low:

                                 Source: Forbes

Real GDP growth in China, actual vs. consensus forecast:

 

                               Source: Tradingeconomics

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Ongoing S&P 500 correction not like 1973, 2000 or 2007

• Since 1938 "super bear" markets resulting in a 40 % or more drop in the S&P 500 from top to bottom has only occurred three times (1973, 2000, 2007)
• Between 1938 and 1973 no "super bear" markets occurred (35 year stretch) 
• Between 1974 and 2000 no "super bear" markets occurred (26 year stretch) 
• Each of the three "super bear" markets have been driven by strong negative fundamentals or out of touch pricing of the index. As the current US and global economy is experiencing healthy growth in combination with a reasonable but somewhat bloated index valuation (see graph #1) I do not believe that we are entering into "super bear" market territory. In fact most S&P 500 sectors are currently trading at or close to 20-yr avg. pricing both on a forward and trailing basis (see graph #2)
• The current correction (10 % drop in index valuation) may turn into a bear market (20 % drop in index valuation), however I do not believe that we are entering into a 2007 - 2008 type of situation as I do not observe a driver for such an event. In my humble opinion the current correction is starting to look like a opportunity to buy stocks on the cheap  

• 1973 (-48.2 %): The termination of the Bretton Woods system in 1971 (gold standard) in combination with the 1973 OPEC oil embargo hurting the US consumer through the devaluation of the dollar and expensive oil. Double digit inflation
• 2000 (-49.1 %): Out of touch market valuation driven by big idea companies often lacking a business plan. Companies were valued by their burn rates and not their profits (or lack thereof). The S&P 500 was valued at a 27.2x forward P/E ratio vs 16.1x today  
• 2007 (-56.8 %): A massive housing bubble was fueled by speculative lending practices which led to a subprime mortgage crisis. The collapse in housing prices in combination with the rising oil price sent the market into the abyss

Graph #1: Current S&P 500 valuation looks somewhat bloated but reasonable (nothing like 2000)

                              Source: JP Morgan


Graph #2: Most S&P 500 sectors are currently trading at or close to 20-yr avg. pricing

                               Source: JP Morgan

Graph #3: 1973 "super bear" market

                                Source: Yardeni Research Inc.

Graph #4: 2000 and 2007 "super bear" markets

                                Source: Yardeni Research Inc.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Statoil fires thousands of employees while borrowing billions to pay dividend

The Norwegian E&P company Statoil which is 67 % state owned is planning to cut NOK 30 billion in expenses while trimming its staff significantly. Reasonable measures considering the ongoing oil price collapse. However Statoil has also decided to borrow funds in order to increase its annual dividend payment to its investors. In 2014 the dividend payment was NOK 33.7 billion. As seen in the below graph, Statoil is currently generating negative cash-flows. 

Statoil YTD Q3 2015 cash-flow:

                                Source: Statoil ASA

During times of normal oil price fluctuations I understand the need to pay a growing annual dividend as this is highly appreciated by investors. Consistent payment of dividend will during normal market cycles ensure lower stock volatility and lower cost of capital for E&P companies. With that said, what we currently are experiencing in the oil market is not a normal market cycle.

Instead of firing employees hand over fist while using borrowed money to pay dividend, Statoil should in my opinion utilize its human capital and financial strength to improve the company´s future growth prospects. It should be common sense to use the current downturn constructively by spending the borrowed money on maintenance, exploration and drilling as such services are cheap these days. Such a move may hurt the stock price in the short-term, however it should enable Statoil to catapult into the next bull market. Both the Statoil investors and the Norwegian people deserve a national oil company which is able to take responsible long-term decisions. Currently Statoil is all about quick fixes.

Average large semisubmersible rig day rates:

                                Source: IHS

Spot rates Offshore Service Vessels:

                                   Source: DVB Bank

Disclosure: I am long Statoil ASA. 

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Berkshire Hathaway offers great value vs. S&P 500

You may find the comparison between Berkshire and the S&P 500 silly as the S&P 500 is a broad diversified share index and Berkshire is only one company. It is important to understand that Berkshire is an investment company holding approximately 50 listed stocks and controls somewhat 60 privately held subsidiaries within various industries. This means that statistically you are covered as far as diversification goes. In theory Berkshire may be the only US stock you have to own. I also keep reading that Berkshire is an insurance company. However for 2014 only USD 7b out of USD 24.5b in EBT for the group stemmed from either insurance or insurance related investment activities. The group´s total non-insurance EBT has increased from 3b to 17.5b from 2004 to 2014. In my perception Berkshire is a large mutual fund/ private equity fund combination that have a tendency to beat the broader market.

Why you should buy Berkshire instead of a S&P 500 ETF: 

• Berkshire has a 0.9 beta, which means that it may hold up better than the S&P 500 in the case of a correction
• Berkshire has somewhat of a support level if the stock falls below the 1.2x book value threshold  as such pricing may trigger a stock buyback program (Warren Buffet stated that 1.2x book value is a bargain compared to intrinsic value). The stock is currently priced at 1.27x book value. For the last ten years the stock has not been priced below 1.05x book value
• Berkshire holds huge amounts of cash which it is ready to deploy if a large market correction should occur. The investment company has a track record of being offered advantageous deals during downturns 
• Berkshire has proved above average performance by following a simple investment strategy: To buy unique but simple businesses with strong positions in the market, with solid management at reasonable prices. The S&P 500 basically holds the 500 largest listed companies in the US, including the ones with weak business models and poor management
• Berkshire has proven over time the ability to grow their book value at a superior rate compared to the S&P 500. Although their absolute return performance has decreased as the group has grown larger, they still have a ROIC of 8.88 % vs. a WACC of 8.15 % meaning that their active investing still produces value above the cost of capital  
• You avoid to invest in the "blue chips of the future" companies such as Amazon, Tesla, Netflix and Facebook which are partly responsible for the current bloated pricing of the S&P 500 with their stretched valuations 
• And at last valuation:                                                                                                  

Berkshire is significantly cheaper on a trailing P/E basis than the S&P 500 (currently 13.89x vs. 20.25x)

                               Source: Gurufocus

Berkshire´s lower P/E does not reflect its superior ability to grow earnings over time

                               Source: Gurufocus

Disclosure: I am long BRK.B. 

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.