Category Archives: SP 500

Which Dividend Futures Are Better?

We have two primary sources for dividend futures data for the S&P 500: the CBOE's four quarterly dividend futures options contracts (DVMR, DVJN, DVST, DVDE) that are set to expire in the months that mark the end of each calendar quarter, whose values are based on active market trading, and IndexArb's bottoms-up estimation of the dividends per share that will be paid out between the date that a given quarter's dividend futures contract will expire and the present.

That's two very different methods for estimating what dividends per share will be in the future. Which method do you suppose is better in explaining the general trajectory of current day stock prices?

To get an idea, we looked at the expectations that both sources of dividend futures data have indicated for the future fourth quarter of 2015 (2015-Q4) on each day since they became active in late December 2014.

CBOE vs IndexArb Dividend Futures for 2015-Q4, 22 December 2014 through 10 April 2015

And here's the actual trajectory of stock prices over the same interval of time from 22 December 2014 through 10 April 2015:

S&P 500 Index Value at Daily Market Close, 22 December 2014 through 10 April 2015

Upon inspection, there's little question that stock prices more closely mirror IndexArb's bottoms-up approach to projecting the expectations of future cash dividends per share.

Unfortunately, IndexArb's dividend futures data has a drawback. Because it counts down the total amount of dividends expected to be paid between the present and the end of the options contract period for a given future quarter, we cannot use its data for the current quarter. And that's a problem for us today because it would appear that investors have once again turned their attention to the current quarter in setting today's stock prices:

S&P 500 Alternative Futures - 2015-Q2 - Standard Model - Snapshot on 10 April 2015

Curiously, the reason investors are now focusing on 2015-Q2 would appear to have changed from what it was just a month ago. Before, investors would focus their attention and set their investing decisions based on their expectations for 2015-Q2 because they expected that the U.S. economy was performing well enough that the U.S. Federal Reserve would act to begin hiking the short term interest rates that it controls before the end of the quarter.

Today, after the disappointing March 2015 employment situation report, the rationale for investors for focusing on this quarter has changed. Instead of the potential for a rate hike occurring before the end of the quarter, they would instead appear to be looking for the Federal Reserve to clarify its intentions for future rate hikes in the very near future, where the choice is now between the late third or fourth quarter of 2015 and an as yet unquantified quarter in the second half of 2016.

The Paradox of Absolute Certainty

There's a long established school of conventional thought that says when uncertainty among investors in the stock market increases, stock prices will fall, and conversely, when their level of uncertainty decreases, stock prices will rise. Whether that's in response to a change in a government policy or a change in a central banking policy,
the thinking is that uncertainty creates fear among investors, who react by sending stock prices lower as they seek to lock in any paper profits they've accumulated over when they originally purchased the shares of stock they sell and increase their cash equivalent holdings.

But shouldn't the opposite be true if the level of certainty of investors in an expected policy action increases to the point where it becomes a stone cold lead pipe lock? Shouldn't stock prices rise when the certainty of investors related to an event occurring becomes virtually absolute?

As we're about to show you, absolutely not!

Let's first step back in time, to Monday, 2 March 2015. On that day, Reuters reported that a near-Fed majority would back a June liftoff for raising short term interest rates, even though Fed Chair Janet Yellen had yet to commit to the plan.

So we find that the certainty level for investors of that event occurring was already high. And as you might expect, since stock prices reflect expectations of future dividends, investors were setting stock prices in accordance with the expectations of future dividends associated with those that will be paid in 2015-Q2, where June 2015 marks the final month.

Alternative Futures for S&P 500, 2015Q1, Snapshot 16 March 2015

But later that week, things changed to where investors became all but absolutely certain that the Fed would indeed act to hike U.S. short term interest rates by the end of 2015-Q2, which was the result of a very robust employment situation report for February 2015. The result of which was that stock prices opened lower and fell throughout the day.

So why didn't they rise instead as conventional thinking would demand?

The answer to that question is that once the probability of an event occurring becomes assured, investors will rationally turn their attention to the areas where they do have uncertainty and reset their future expectations accordingly. As you can see in our chart above, they would appear to have turned their attention forward to the more distant future represented by the expectations associated with the amount of dividends that will be paid out to shareholders in 2015-Q4.

And so we see that as the possibility of a Fed rate hike in June 2015 went from what had previously been an event with a high probability of occurring to an all-but-certainty, instead of locking in to the higher level of expectations of future dividends at that point of time, that near absolute certainty actually freed investors to look forward to a different period of time beyond where they had previously focused. In this case, since those expectations were not as positive as those associated with 2015-Q2, stock prices fell.

And through today, 16 March 2015, they remain consistent with investors being focused on 2015-Q4 in setting today's stock prices.

Or as we like to say, the way stock prices behave is chaotic and complex, where the only real randomness in the market was tied to the timing of new information and the investors' selection of a different future quarter to focus upon. And even without knowing those two things in advance, where stock prices finalized was still largely predictable within a few percentage points of what we subtly forecast weeks upon weeks ago for how it all played out.

Dividends: U.S. Continues Economic Contraction in February 2015

Following its apparent contraction in January 2015, it appears that the U.S. economy continued to contract in February 2015.

We're basing that assertion on the number of publicly-traded U.S. companies that announced they would be reducing their cash dividend payments to their shareholders during the month of February 2015. With 38 companies taking that action, the number is lower than the 57 firms that took similar actions in January 2015, but is still well elevated above the number that would appear to correspond to a shrinking economy.

Monthly Number of Public U.S. Companies Announcing Dividend Cuts, 
January 2004 through Present (February 2015)

We believe that the number of companies cutting their dividends in February 2015 is a better indicator of the current level of distress within the U.S. economy than the higher January 2015 figure, because we suspect that earlier figure was elevated by those companies whose deteriorating business outlook was such that they should have acted to cut their dividends in 2014, but delayed until the new year.

Speaking of which, we think we've identified most of the entities whose stocks trade on the NYSE or NASDAQ stock market exchanges, using data from Seeking Alpha's Market Currents reports (filtered for Dividends) and the Wall Street Journal's daily listing of Dividends Declarations. The table below presents the full list that we were able to assemble from these sources:

Publicly Traded U.S. Companies Cutting Dividends in February 2015
Date Company Symbol Old Dividends per Share New Dividends per Share Percent Change
2-Feb-2015 North Eur Oil Royalty Tr NRT $0.39000 $0.35000 -10.3%
2-Feb-2015 EV Energy Partners EVEP $0.77400 $0.50000 -35.4%
4-Feb-2015 EV Energy Partners LP EVEP $0.77400 $0.50000 -35.4%
4-Feb-2015 Nuveen Lgn/Sh Cmdty TR Fd CTF $0.13500 $0.11900 -11.9%
5-Feb-2015 Sabine Royalty Tr UBI SBR $0.28281 $0.27708 -2.0%
5-Feb-2015 Magic Software MGIC $0.09500 $0.08100 -14.7%
6-Feb-2015 Alon USA Partners L.P. ALDW $1.02000 $0.70000 -31.4%
6-Feb-2015 Chesapeake Granite Wash CHKR $0.50790 $0.44960 -11.5%
6-Feb-2015 ECA Marcellus Trust I ECT $0.20300 $0.18000 -11.3%
6-Feb-2015 Evolution Petroleum EPM $0.10000 $0.05000 -50.0%
6-Feb-2015 STRATS Sers 2006-1 P&G . Ser 2006-1 GJR $0.01570 $0.01535 -2.2%
6-Feb-2015 STRATS Tr Allstate 2006-3 GJT $0.01752 $0.01708 -2.5%
9-Feb-2015 Northern Tier Energy LP NTI $1.00000 $0.49000 -51.0%
9-Feb-2015 Whiting USA Trust I WHX $0.50934 $0.28308 -44.4%
9-Feb-2015 Whiting USA Trust II WHZ $0.64201 $0.32726 -49.0%
10-Feb-2015 Medley Capital MCC $0.37000 $0.30000 -18.9%
10-Feb-2015 Oaktree Capital Group OAK $0.62000 $0.56000 -9.7%
10-Feb-2015 PPLUS FR Call Ser GSC-2 PYT $0.19583 $0.19167 -2.1%
11-Feb-2015 Fifth St Finance FSC $0.09170 $0.06000 -34.6%
11-Feb-2015 KKR KKR $0.45000 $0.35000 -22.2%
12-Feb-2015 Ellington Financial EFC $0.25278 $0.25000 -1.1%
12-Feb-2015 SunTr Banks Dep. Shs STIA $0.77000 $0.65000 -15.6%
12-Feb-2015 Pengrowth Energy PGH $0.04000 $0.02000 -50.0%
13-Feb-2015 Deswell Industries DSWL $0.05000 $0.03500 -30.0%
18-Feb-2015 Cross Timbers Royalty Tr CRT $0.16025 $0.15170 -5.3%
18-Feb-2015 Hugoton Royalty Tr Un HGT $0.03968 $0.03609 -9.0%
18-Feb-2015 Permian Basin PBT $0.03673 $0.03146 -14.3%
19-Feb-2015 MetLife Floating Ser A META $0.25278 $0.25000 -1.1%
20-Feb-2015 CVR Energy CVI $0.75000 $0.50000 -33.3%
20-Feb-2015 CVR Refining L.P. CVRR $0.54000 $0.37000 -31.5%
20-Feb-2015 Dom Res Black Warrior Tr DOM $0.18065 $0.17455 -3.4%
20-Feb-2015 Vanguard Natural Rscs VNR $0.21000 $0.11750 -44.0%
26-Feb-2015 Mesa Royalty Tr MTR $0.16336 $0.07262 -55.5%
26-Feb-2015 Pacific Coast Oil Trust ROYT $0.03212 $0.00614 -80.9%
26-Feb-2015 Safe Bulkers SB $0.04000 $0.02000 -50.0%
28-Feb-2015 Full Circle Capital FULL $0.06700 $0.03500 -47.8%
28-Feb-2015 Lamar Advertising Co LAMR $0.84000 $0.68000 -19.0%
28-Feb-2015 TICC Capital Corp TICC $0.29000 $0.27000 -6.9%

The list predominantly consists of small, oil industry or other natural resource extraction-related firms, which is connected to the large and so-far sustained decline in global oil prices that began in July 2014 that has negatively affected their revenues. There are also a number of financial firms on the list that have also declined with these industries, along with a sprinkling of firms in other industries, such as software and advertising.

That these firms are small is a key reason why stock market indices have not followed suit. The dividend cuts represented by these firms simply are not big enough to even move the needle for market capitalization weighted indices like the S&P 500.

That is perhaps surprising considering how dramatically the index' expected future earnings per share through 2015 has changed over the past three months. However, that can be easily explained as most larger companies operate with greater margins of safety that allow them to absorb volatility in their expected earnings without cutting promised dividends, at least in the short term, which is why their stock prices haven't collapsed along with their projected earnings. Which is just what we should expect to happen since expectations for dividends per share, and not earnings, are the fundamental driver of stock prices.

So far, those cuts in expected future earnings haven't really transformed into cuts in expected future dividends. What they do represent however is a much more difficult business environment for the U.S. oil industry, where the distress is forcing dramatic cuts to extraction and to exploration activities, which is already negatively impacting other businesses that support the industry as these companies are instituting massive cuts to their spending as they struggle to remain solvent.

Under U.S. law, firms that will be laying off significant numbers of workers must provide their affected employees at least 60 days of notice in advance of the layoffs taking effect. Since January and February 2015 has seen many announcements of such mass layoffs in the industry, which will extend beyond mere oil workers, we should see a considerable increase in the number of Americans filing initial unemployment insurance claims in March and April 2015 should the recent rebound in oil prices not prove to be sufficient to forestall tens of thousands of pending layoffs in the industry.

Data Source

Standard & Poor. Monthly Dividend Action Report. [Excel Spreadsheet]. Accessed 2 March 2015.


In Which We Provide Forward Guidance to the Fed

Of all the things we never expected to find ourselves doing, providing policy guidance to the Federal Reserve is probably at the top of the list.

That's all the more unexpected because we've never had any contact with any official at any level of any branch of the U.S.' central banking institution.

NASA - Source: http://www.nasa.gov/centers/langley/news/researchernews/rn_HorowitzLeaderDog_prt.htm

And yet, if you listen to the things that a number of the Fed's most influential officials have been saying, you'll find our fingerprints all over them.

It all begins with some key observations and insights we've offered over the years. On that count, our having quantified how the action of investors collectively shifting their forward looking focus from one discrete point of time in the future to another point of time in the future can influence otherwise inexplicable changes in stock prices is likely our major contribution, followed by our observation that the Fed was using stock prices to assess the effectiveness of its monetary policies.

Those two things together allowed us to identify and quantify mistakes made by top Fed officials as they attempted to provide forward guidance to markets. And that, in turn, allowed us to describe how they could repair the damage and more effectively use forward guidance as a monetary policy tool by emphasizing the timing of when the Fed will implement changes using its more traditional arsenal of tools.

The Fed was listening. Now they're applying the lessons they've gleaned from our observations and suggestions.

Over the last several weeks, we've been observing, with increasing frequency, the statements of highly influential Fed officials who have gone out of their way to set the expectation that the Fed will begin hiking short term interest rates above its current 0-to-0.25% level by the end of the second quarter of 2015.

And we know that forward guidance has been effective because of the trajectory that U.S. stock prices has taken during these last several weeks, which becomes even more clear after our simple adjustments to account for the past volatility of U.S. stock prices, which we use as the base reference points from which we can otherwise project future stock prices within a relatively narrow range of noise.

Alternative Futures for S&P 500, 2015Q1 Likely Trajectories for Stock Prices When Investors Are Focused on Indicated Future Quarter

Provided, of course, that we know just how far investors are peering into the future when they make their investment decisions today, which is why we show each of the likely trajectories for investors focused on any of the next four quarters ending in the future. And that's where the Fed's forward guidance efforts come into play, because the Fed's outsized ability to affect interest rates can affect how far forward in time investors look from the present, which then tells us which future trajectory to follow. At least while investors aren't distracted by the alternative futures.

Guide Right Forward March - Source: http://www.loc.gov/resource/ihas.200211693.0/?sp=1

The way that works is that when the Fed says it is going to do something by the end of a certain time period, investors will adapt their investments to be consistent with the expectations for the investment returns that associated with that period of time in the future. We can then tell from the actual trajectory that stock prices follow how tightly investors have set their forward looking focus on the quarter that coincides with the anticipate action on the part of the Fed.

That's the way in which the Fed's forward guidance has been shaped and made more effective, even at the so-called lower zero bound, by our insights and what the Fed has absorbed from our guidance of how to better employ this tool. As long as the Fed's action is considered to be credible given the current state of economic affairs, the Fed can use the model we've developed of how stock prices work as a means of assessing the degree to which markets have bought in to the Fed's preferred policies.

Here, the greater the deviation from the projected trajectory associated with the future point of time to which the Fed has directed investors, the more statements or actions using the other tools the Fed has available to it will be needed to bolster the credibility of its preferred policy. If the gap can't be closed after all that, that provides the indication the Fed needs that it should pursue a different, and more credible, policy.

The best part? It doesn't matter if you've never heard of us or even believe any of what we've just described is possible. It is the way the world works, whether you like it, understand it, or not.

As for what good this does, if you happen to be an investor or just someone who needed more economic stability before you could justify proceeding with plans to expand your business or investments in today's world, you've benefited from the Fed's more effective implementation of its forward guidance policy. As for us and our role in providing guidance to the Fed in implementing those forward guidance policies since mid-2013, you're welcome.

Winter 2015 Snapshot of Expected Future S&P 500 Earnings

Every three months, we take a snapshot of the expectations for future earnings in the S&P 500. As we'll show you today, expected earnings per share for the S&P 500 throughout 2015 have plummeted from the levels that Standard and Poor had projected they would be back in November 2014.

Forecasts for S&P 500 Trailing Twelve Month Earnings per Share, 2010-2015, Snapshot on 15 February 2015

The table below quantifies the carnage for what can now be described as the very sudden onset of an earnings recession, one that is currently forecast to run through the third quarter of 2015:

Expected Future Earnings per Share for the S&P 500
Future Quarter 2014-Q4 2015-Q1 2015-Q2 2015-Q3 2015-Q4
On 13 November 2014 $109.96 $118.23 $124.48 $131.07 $134.89
On 15 February 2015 $102.89 $103.34 $103.77 $105.00 $112.83
Change in Expectations -$7.07 -$14.89 -$20.71 -$26.07 -$22.86

Much of the decline in earnings expectations is tied to the decline in global oil prices, which primarily affects the oil industry, and also affects the business outlook for financial institutions and capital equipment manufacturers.

It is also interesting to note a comment by S&P's Howard Silverblatt regarding the extent to which a significant number of companies in the S&P 500 have reduced the number of shares that are outstanding in the market:

Q1, Q2 and Q3 2014 had 20% of the issues, 1-in-5, reducing their year-over-year share count by at least 4%, therefore adding at least a 4% tailwind to their current EPS.

If not for those actions to reduce the number of outstanding shares in the market in 2014, the earnings per share data would appear far worse, and the outcome for 2014-Q4, for which earnings are still in the process of being reported, would be even more negative. The same would be true for the index' dividends per share.

More significantly, since expectations for dividends per share are the primary driver for stock prices, it would be safe to say that the outcome for stock prices in 2014 would not have been as positive as they turned out to be in the absence of such financial engineering.

Data Source

Silverblatt, Howard. S&P Indices Market Attribute Series. S&P 500 Monthly Performance Data. S&P 500 Earnings and Estimate Report. [Excel Spreadsheet]. Last Updated 15 February 2015. Accessed 18 February 2015.