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Tuesday, November 05, 2013

Winning Strategies During the Market’s Best Historical Season
By Louis Navellier

Through November 1, the S&P 500 is up over 23% year-to-date, mostly courtesy of the Fed’s continuing policy of $85 billion per month in quantitative easing (QE). Last Wednesday, the Federal Open Market Committee (FOMC) once again confirmed that economic conditions remain too weak to “taper” QE.

Also on Wednesday, ADP reported that only 130,000 private payroll jobs were added in October. ADP also revised down September’s job totals to 145,000, from 166,000. Next Friday’s payroll report will likely deliver a similar number, partly due to the federal government shutdown in the first half of October. Some economists are estimating the unemployment rate will jump to 7.5%, from 7.2% in September.

Despite this string of disappointing statistics, Wall Street seems a bit relieved that the unemployment situation is bad enough that the Fed will continue its $85 billion per month in quantitative easing.

In this week’s MarketMail, my colleague Gary Alexander will show you where we stand in this bull market while Ivan Martchev will look at the “phantom inflation” risk for income investors. Read More.

In This Issue

Growth Mail: The Best Buying Time is …. NOW! – by Gary Alexander
November and December Bring Holidays… and Superior Profits
In a Five-Year-Old Bull Market, Stock Selection Becomes Paramount

Income Mail: A Curious Case of Missing Inflation – by Ivan Martchev
Japan is Finally Turning from Deflation to Inflation
Some Income Strategies While Inflation Remains Ultra-Low

Growth Mail

November is Still Your Best Buying Month of the Year
By Gary Alexander

Through November 1 of this year, the NASDAQ is up 29.9%, the Dow is up 19.2%, and the most comprehensive U.S. blue chip stock index, the S&P 500, is up 23.5%. Pinch yourself. Are we dreaming? How can the market perform so well in such a slow-recovering economy and a government in a seemingly permanent state of disrepair? Can we possibly keep steaming ahead from this point forward?

History (and market fundamentals) say the clear answer is YES. Let’s start with history. November is typically one of the best months on the calendar to buy stocks. Since 1950, the S&P has risen an average 1.6% in November, but that’s just the appetizer. November often begins the best three months of the year (through January 31) and the best six months (through April 30). Winter provides the payoff of the “Sell in May and Go Away” strategy. The flip side of that chestnut would be “…then Remember to Buy in November.”

We don’t advise selling in May, but if you did, it’s not too late to buy now. In the last 20 years – through three great bull markets and two painful bear markets – the six cold months (November through April) have averaged gains of 6.6%, while the six warmer months (May through October) have averaged just 1.1% gains. The trend is even more dramatic in recent years. Since 1998, the S&P 500 has gained an aggregate total of 145% in the six colder months, while it has LOST 28% in the six warmer months.

In the last four years of this bull market, the cold months (November 1 to April 30) delivered 66.5% gains in the S&P 500, while the warm months (May 1 to October 31) delivered microscopic gains of just 1.8%.

S&P Performance in Cold Months vs. Warm Months, 2010-2013

  • For the Six Months Ending:
  • YearApril 30October 31
  • 2010+14.52%-0.29%
  • 2011+15.24%-8.09%
  • 2012+11.54%+1.02%
  • 2013+13.13%+9.95%
  • Total+66.53%+1.79%

Source: S&P 500, Yahoo Finance

There are several sound reasons why markets tend to rise from November through April. Louis Navellier has written that “seasonal strength is typically caused by year-end pension funding as well as folks tending to be happier during the holidays. As we gather to celebrate Thanksgiving with friends, family, food, and football, consumer sentiment tends to improve, which usually rubs off on investor sentiment and causes an early January Effect. These positive feelings typically continue in the New Year when the stock market benefits from persistent inflows caused by more pension funding in a new year. These strong inflows typically persist through April, so the next six months could be strong.”

November and December Bring Holidays… and Superior Profits

Turning to the shorter term, November as a standalone month has been superb, and so has December, so time’s a wasting for the fence-sitters among us. According to Bespoke Investment Group (BIG), November is the second best month in the last 20 years, behind only April, and December comes in at #3. The Dow Jones Industrials have averaged 1.88% in the last 20 Novembers, while the S&P 500 isn’t far behind at 1.68%.

The track record is even better in good market years, like this. According to Bespoke, “In the 35 years (since 1928) in which the S&P 500 has been up more than 10% year-to-date through October, the S&P 500 has averaged a November gain of 2.57% with positive returns 73.5% of the time. Over the final two months of these years, the S&P has averaged a gain of nearly 5% with positive returns 82.4% of the time.”

In the 13 years in which the S&P has risen over 20% through October 31 (like this year), Bespoke adds: “The average November return gets even better at +3.22% with positive returns in all but two years (1938 and 1943). The last two times the S&P 500 was up more than 20% YTD through October were in 1995 and 1997. In 1995, the index gained 4.1% in November and 5.92% through year end, while in 1997, the index gained 4.46% and 6.1% through year end.” By contrast, November is soft when the full year is bad.

Last week, I told you how Bespoke said the market is “overbought,” and I questioned why anyone would sell based on that fact alone, since previously overbought markets stayed overbought for a long time.

Bespoke provided further proof of this fact in the following paragraph: “Following most periods where the S&P 500 traded to overbought levels, it continued to stay overbought. In fact, so far this year, the S&P 500 has closed the day at overbought levels on 137 out of 212 trading days (65%). Compounding the frustration even further, when the correction finally did occur, the market bottomed above the levels it was trading at when it first became overbought. If you think 2013 has been frustrating, though, just thank yourself that this is not 1995, 1954, or for that matter even 1958. In all three of these years, the S&P 500 closed at technically ‘overbought’ levels at least 74% of the time…. In both of these years, the S&P 500 finished the day at ‘overbought’ levels on an astonishing 81% of all trading days.”

In a Five-Year-Old Bull Market, Stock Selection Becomes Paramount

The market will likely keep rising, but that does not mean all stocks will rise evenly. Several Navellier analysts have told me recently that they see thinner breadth in this market. The averages are rising on the strength of fewer and fewer stocks. Last week, I compared this earnings season to a tepid pool of equal parts boiling water and ice. This is the time in a bull market when stock selection becomes paramount.

Once again, I’ll quote Louis: “Even though a lot of market pundits like to say that indexing is better than active portfolio management, I have never heard one of these pundits admit that indexing caused the bubble in technology stocks back in March 2000 when 54% of the S&P 500 ended up in seven giant technology stocks due to the capitalization weighting associated with the S&P 500. In other words, much of the technology bubble that formed in the late 1990s underneath Cisco Systems, Oracle, and other large technology stocks burst in March 2000, due to the capitalization weighting that created a feeding frenzy.”

We believe now is the time to “look under the hood” of each stock you buy, rather than buying index funds or the biggest-cap fad stocks. Even in a solid bull market, traders tend to resemble a manic crowd that buys or sells first, then watches the tape, then regrets undertaking such a hasty action. As more brokers merely “chase” stocks, few are looking under the hood at the bubbles of excessive valuations that are forming.

Due to the recent flight to quality, it’s important to find advisors who are willing to examine each stock rather than jumping into the overall market. Look for the stocks with the strongest sales and earnings momentum, and also remember to trim stocks when they become over-weighted after outrunning the overall market. This stock market remains very selective, so now might be the best time in the bull market to consider one or more of the Navellier-managed growth portfolios (see www.navellier.com).

Income Mail

The Curious Case of Declining U.S. Inflation Rates
By Ivan Martchev

Inflation is one of the biggest enemies of income investors. Most bonds, save for TIPS, do not have built-in inflation protection. Inflation can make bond prices decline as interest rates rise, and the purchasing power of money goes down. So the good news for most bond holders is that the U.S. inflation rate is drifting lower. The same declining trend is visible in the US core inflation rate (ex-food and energy).

Last week, the Labor Department reported the Producer Price Index (PPI) fell by 0.1% in September, well below economists’ consensus estimate of a 0.3% increase. Excluding food and energy, the core PPI rose 0.1%. In the past 12 months, the PPI has risen only 0.3%, the lowest annual rate since October 2009.

The Consumer Price Index (CPI) has a barely-noticeable pulse, but it’s still quite tame. The CPI rose 0.2% in September, while the core CPI rose only 0.1%. In the past 12 months, the CPI has risen 1.2%, while the core CPI rose 1.7%, so inflation remains well below the Fed’s target rate of 2.0% to 2.5%.

Income investors must wonder why the Federal Reserve has an “inflation target” at all. The reason is that the Fed says that if inflation falls too far below 2%, then the economy might stall as people postpone their investment decisions, due to weak revenues, which would likely cause employment growth to stagnate.

Economies with very low inflation – or deflation – tend to exhibit sub-par growth. Deflation also tends to suppress corporate revenues and make debt servicing problematic, leaving less money for dividends.

So – a little inflation is good, but too little inflation (or deflation) is not good for income investors

Japan is Finally Turning its Long-term Deflation into Rising Inflation

The Fed has been watching Japan, where persistent deflation since the mid-1990s has resulted in sub-par growth for decades. Japan’s sad experience is one reason the Fed is undertaking long-term QE, and this is why the Fed came out in support of Japan’s QE policies, which have been ongoing since April.

The Japanese inflation rate is beginning to rise in the latter part of 2013. So, why does Japan have rising inflation under its version of QE, while we have a falling inflation rate after years of the Fed’s QE?

Japan’s QE is very different. It is three times more aggressive, relative to the size of its GDP, and it uses different channels for pumping money into the economy, which helps produce a higher inflation rate. (For more on Japan’s QE, see my article on MarketWatch “Repercussions from the Yen Surge”.)

In the U.S., QE is designed to lower long-term interest rates, and there are central bank precautions in order to not create extra inflation. I think Mr. Bernanke surprised the markets in September by refusing to taper because even he was surprised how much U.S. inflation has fallen. I know there are things the U.S. Central Bank can do, similar to the Japanese version of QE, to raise the U.S. inflation rate, but the Fed may feel it has gone far enough. If it goes farther in its monetary experiment, it may create a bigger-than-palatable international political problem given the reserve status of the U.S. dollar.

While there is little undesirable fallout from the U.S. version of QE, foreign exchange reserve holders must be getting understandably nervous. In theory, Chairman Bernanke, and his likely successor Janet Yellen, may think they can keep QE ad infinitum, but this will not likely be possible, politically. For the time being, this means Chairman Bernanke will likely leave the tapering decision to his successor.

Some Income Strategies While Inflation Remains Super-Low

For income investors, low inflation means we should consider concentrating on stocks with stable and growing dividends, stocks that can withstand economic shocks. There is too little yield in bonds that have tight spreads to Treasuries—like AA and A—so we believe the best place to look for yield in the bond market remains lower-quality investment grade bonds, like BB. With BB bonds, there is enough yield for buy and-hold investors as well as a big-enough spread to Treasuries to shield them a bit from QE tapering gyrations.

The good news on the dividend front has been that for the past five quarters, on a 12-month trailing basis, companies in the S&P 500 have been paying record dividends as a total dollar amount. According to the FactSet September 16 Dividend Quarterly, aggregate dividends per share (DPS) grew 15.7% year-over-year, while the quarterly dollar-value dividend payments of $82.6 billion amounted to the second-largest sum over a 10-year horizon. (Note: The #1 quarter was due to accelerated payments and special distributions at the end of 2012, which pushed the Q4 2012 total to a record $92 billion.)

In addition, dividend payments over the trailing twelve months (TTM) of $329 billion amounted to the largest TTM total over a 10-year horizon. The current TTM is more than double the levels from 2003 and 37.6% greater than the 10-year average. This impressive dividend growth has helped the aggregate yield of the S&P 500 Index remain above 2% over two years despite the downward pressure from strong stock market performance. The S&P 500 has returned 30.4% from Q2 2011 to Q2 2013, while the TTM DPS of the index has increased by over 31.4% in the same span.

While the S&P 500 offers a far-from-record-high yield, the record (and growing) total value of dividends paid is great news for income investors. The S&P Index has a dividend payout ratio of 31.8%, which means it has room to grow. Some of the largest dividend increases have been from formerly-stingy economic sectors like technology, which have the cash flows to keep up the rapid dividend growth rate.

For instance, few know that Apple* (AAPL) is the second-highest payer of dividends in the S&P 500 (i.e., by total amount paid, not percent yield), behind only ExxonMobil* (XOM). Both AAPL and XOM have payout ratios of 29%, indicating that their dividends have room to move higher should management decide it is in the best interest of their shareholders.

All of the above suggests that in this low-and-falling inflation scenario, we believeincome investors should continue doing what they have been doing in the past 3-4 years, i.e., focus on mid-tier quality bonds and dividend-paying stocks. How and when QE tapering unfolds in 2014 will tell us if we need to change that strategy.



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