Category Archives: SP 500

Growing Calm or the Calm Before the Storm?

After a rough July, in which the number of U.S. firms announcing dividend cuts directly paced what we saw during the first quarter of 2015, it would appear that the U.S. economy in August is shaping up to be much less severe. Our near real time indicator of the relative level of economic distress in the U.S. economy is now suggesting only that recessionary conditions are present in the U.S. economy in August 2015, rather than the kind of contraction that we observed in the near-zero growth of first quarter.

Cumulative Number of Announced Dividend Cuts by Day of Quarter, 2015-Q1, Q2 and Q3, Snapshot on 2015-08-14

But instead of being a cause for celebration, we have to address a significant and growing cause for concern. The main thing that drove the heightened level of distress in the U.S. economy back in 2015-Q1 was the fall of crude oil prices below $50 per barrel, which primarily hammered small-to-mid-sized U.S. oil producers, many of whom responded by slashing their cash dividend payments to their shareholder owners, while they also slashed their plans for expansion, which in turn, negatively affected things like durable goods providers.

Those negative conditions abated during the second quarter of 2015 as crude oil prices stabilized, but over the past month, crude oil prices have once again resumed their significant decline, with the price of West Texas Intermediate crude oil falling by almost 20% since mid-July 2015.

As we saw back in January 2015, the number of dividend cut announcements for U.S. oil and gas extraction firms lagged behind the declines in price that had begun soon after 4 July 2014. We think that if the decline is not reversed, whether by an improvement in the oil industry's overall fundamentals or the devaluation of the U.S. dollar, it is likely that the level of distress in this sector of the U.S. economy will once again increase, forcing an increased number of firms to cut their dividends.

The big question for investors is how long can oil prices continue falling or remain depressed below their previous levels before the level of distress in the industry expands to its largest producers. Already, the decline in oil prices is negatively impacting the earnings of firms such as Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX), who are already on track to reduce their new exploration and production operations.

With the decline in oil prices to date, Exxon Mobil has already fallen from being the largest component by market capitalization in the S&P 500 to now be the index' third largest firm, while Chevron has dropped out of the S&P 500's Top 20 component firms altogether. Even so reduced, should these firms act to cut their dividends, the effect will be felt across the entire index.

So we're left with the question of whether what we're seeing now is a growing level of calm in the U.S. economy and stock market, or is what we're seeing now just the calm before the storm hits?

Data Sources

Seeking Alpha Market Currents. Filtered for Dividends. [Online Database]. Accessed 15 August 2015.

Wall Street Journal. Dividend Declarations. [Online Database]. Accessed 15 August 2015.

Winning Streaks and the S&P 500

Since we counted up all of the S&P 500's losing streaks by their duration earlier this week, we thought we'd follow up and repeat the exercise for all the S&P 500's winning streaks before the week ended. The chart below shows our results:

We find that while the number of two-day-long winning streaks is lower than the number of two-day-long losing streaks, once we get to streaks of three days or longer, the number of winning streaks outnumber the numbers of losing streaks for each duration.

Not only that, we find that the longest winning streak of 14 consecutive trading days for the S&P 500, which ran from 26 March 1971 through 15 April 1971, is longer than the longest losing streak, which ended after 12 consecutive down days for the index.

Digging into the history of the market of that time, we didn't find any evidence of a change in the Federal Reserve's monetary policy influencing the expectations that drive stock prices at that time, although we will note that just seven days earlier on 19 March 1971, Fed Chair Arthur F. Burns met with President Richard Nixon in the White House, where the President first broached the topic of having the Federal Reserve act to manipulate the U.S. economy to the President's favor in the upcoming 1972 election year. However, although Burns was predisposed to be loyal to President Nixon, it wouldn't be until Fall 1971 that the Fed would really go all out to "goose" the economy by pushing down interest rates below their natural rate a year ahead of the national elections in 1972.

Instead, we think the best explanation for the longest ever recorded winning streak for the S&P 500 had a lot more to do with interest rates hitting a low point during the mid-March to mid-April 1971 time frame, after which they quickly rebounded back up to the levels at which they had started the year.

As for the Fed's stimulative actions, they achieved the desired effect as President Nixon sailed to re-election. But with one really nasty side effect, as it initated the massive inflation that characterized the rest of the 1970s. And though it did help provide a short term positive boost to U.S. stock prices, it couldn't be sustained and where stock prices were concerned, the 1970s was, on the whole, a period of stagnation.

Losing Streaks in the S&P 500

We don't normally follow the Dow Industrials index (NYSE: DJI), since it really doesn't capture enough of the breadth of the U.S. stock market, but last Friday, 7 August 2015 saw a pretty rare occurrence, with the Dow having closed lower than the previous day for the seventh consecutive trading day in a row.

While the S&P 500 fared slightly better by that measure over that same period of time, declining in only six of the same seven days, we wondered what its worst streaks were over its entire history.

To find out, we tapped Yahoo! Finance's S&P 500 historical price database and ran the numbers. The chart below reveals the number and duration of two or more consecutively down days that the index has recorded over the 16,506 trading days from 4 January 1950 through 7 August 2015.

Number of Two or More Consecutively Down Days for the S&P 500, 4 January 1950 through 7 August 2015

Since 4 January 1950, we see that the S&P 500 has had losing streaks run seven tradings days or longer some 44 times, with 23 of those streaks lasting exactly seven days before the index recorded an up day to break its losing streak.

The longest losing streak recorded over this period of time lasted twelve consecutive trading days, which began after it peaked on 21 April 1966 and lasted through 9 May 1966.

The timing of that longest losing streak roughly corresponds to the fallout from the Fed's decision on 12 April 1966 to begin "'restricting' rather than 'moderating' the growth in the reserve base, bank credit, and the money supply" available to the U.S. financial system, inaugurating a prolonged period of increased distress for the U.S. economy. That distress was indicated by the reversing momentum of the S&P 500 index, where it coasted on its previous upward inertia to top at 92.42 on 21 April 1966, after which it entered into a general period of decline until it finally bottomed at 73.20 on 7 October 1966, some 20.7% below its previous peak level. It would not recover to that former peak until 27 April 1967.

Unless there is significant erosion in the expectations for future dividends or a significant negative noise event, that kind of decline is unlikely to occur in today's market, but the general trend our rebaselined model of how stock prices work currently forecasts is such that the remainder of August 2015 would appear to be set to follow a downward trajectory.

Alternative Futures - S&P 500 - Rebaselined Model - Snapshot on 7 August 2015

Things would appear set to improve in September 2015, with the biggest boost coinciding with the timing of the Federal Reserve's Open Market Committee meeting in the middle of that month, but our limited ability to peer into the farther future suggests that would provide only a short term boost, as 2015 on the whole would appear to be set to be best described as a year of relative stagnation for U.S. stock prices.

The Dragons Beyond the Edge of the Map and the S&P 500

Last week, we considered what the potential impact of stock buybacks would be to the S&P 500 as if the venerable stock market index was the stock price of a single company. We concluded our analysis as follows:

What does that mean for the market going forward? We'll let a JPMorgan analyst's comments from May 2013 (via ZeroHedge) explain:
"The other side effect of elevated dividends and share buybacks is that these distributions to shareholders may reduce the long term potential of the company to grow relative to the alternative of capital spending."
Two years later, that dynamic would be a major reason why the upward growth of the S&P 500 has largely stalled out through the first seven months of 2015, which through Friday, 24 July 2015, is less than 1% higher than it was at the end of 2014. It likely took longer than they expected, but scenario described by JPMorgan's analyst arrived all the same.

But not for the reasons they believe.

To understand why, you have to appreciate the central fallacy we built into our "what if" analysis, which involved treating the value of the S&P 500 index as if it were the share price of a single company. To understand why that's wrong requires a brief review of S&P's U.S. Indices Methodology:

On any given day, the index value is the quotient of the total float-adjusted market capitalization of the index’s constituents and its divisor. Continuity in index values is maintained by adjusting the divisor for all changes in the constituents’ share capital after the base date. This includes additions and deletions to the index, rights issues, share buybacks and issuances, and spin-offs. The divisor’s time series is, in effect, a chronological summary of all changes affecting the base capital of the index. The divisor is adjusted such that the index value at an instant just prior to a change in base capital equals the index value at an instant immediately following that change.

Because of those adjustments, it is not correct to apply the same math as would apply to the stock price of a single company as we did in our "what if" analysis, as the value of the index is continually adjusted to account for the effect of share buybacks on each component stock's market capitalization weighting as they occur. [The math that's used is explained in this PDF Document.]

So if you're an investor looking to the S&P 500 index to capitalize on share buybacks, you're investing in the wrong place. To that end, S&P also maintains an equal-weighted share buyback index that might be more suited to you, which the Financial Lexicon has ably described.

As for the real reason the S&P 500 is stalling out, you don't need to look any further than the lack of adequate momentum for growing the index' future dividends (or rather, the sustainable portion of earnings that are likely to be realized in the future), whose upward growth has been likewise stalling out. Speaking of which, let's take a look at what our rebaselined model is projecting for the future trajectory of the S&P 500 through 2015-Q3, as our standard model reached the edge of its map of the future:

S&P 500 Alternative Futures - 2015Q3 - Rebaselined Model - Snapshot 30 July 2015

We confirm that through 30 July 2015, investors remained closely focused on the third quarter of 2015, where the expectations associated with the quarter, which ends in September, driving their investment decisions. The "2015 Greek Bailout" minor speculation bubble that had prompted the S&P 500 to run hot two weeks ago has fully dissipated.

So at least the dragons that be on this side of the map's edge are familiar ones!

References

Standard and Poor. S&P Dow Jones Indices: Index Methodology. [PDF Document]. March 2015. Accessed 31 July 2015.

The S&P 500 and Stock Buybacks

How different would the value of the S&P 500 be if not for the amount of stock buybacks that have taken place in the U.S. stock market since the end of 2008?

We're asking that question today because of the recent suggestion that "Wall Street's new drug is the stock buyback":

In the first quarter of 2015, companies in the S&P 500 index returned more money to shareholders than they earned. The last time that happened was in the fourth quarter of 2008, when the entire S&P 500 reported a slight loss for the quarter but still spent $110 billion on dividends and buybacks.
“This is not a normal trend,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. “This is a large amount of money being returned with the majority of it in buybacks.”
In the first quarter, S&P 500 companies spent $237.69 billion on dividends and buybacks, while reporting operating earnings of $228.36 billion, according to data compiled by Silverblatt.
[...]
According to recent data from S&P, total buybacks and dividends (assuming those dividends were reinvested) have accounted for 35% of the buildup in market cap for the S&P 500 since it bottomed out in 2009. Without dividends, buybacks alone have accounted for 21% of the market cap’s rise.

To approximate what that change means in terms of the value of the S&P 500 index, we're going to treat the S&P 500 index as if it were a single company, which means that we will not be accounting for the market cap-based weighting of the buybacks that a number of the index' component firms have executed since the end of 2008.

We then calculated the S&P 500's equivalent number of shares by dividing its market capitalization at the end of each quarter since 2008 for which S&P has provided data (Excel Spreadsheet) by the index's value at the end of each quarter (Excel Spreadsheet). We then applied the same math to determine the equivalent number of shares that would have been bought back during each quarter.

Then, starting with the equivalent number of shares we calculated for the S&P 500 at the end of the fourth quarter of 2008, we progressively added the net change in the number of equivalent shares between each subsequent quarter and its preceding quarter to that base figure, while also adding back the equivalent number of shares that were consumed by buybacks for each quarter.

Our last step was to take each quarter's reported market capitalization and to divide it by the number of equivalent shares from our hypothetical "no stock buyback" parallel universe to calculate what the value of the S&P 500 index would be in that alternate reality. Our results are visualized in the following chart.

Quarter-Ending Value of S&P 500 Index, 2008-Q4 through 2015-Q1, With and Without Stock Buybacks

What we see from our highly simplified, back-of-the-envelope math is that through the end of the first quarter of 2015, the most recent for which S&P has reported data at this writing, the value of the S&P 500 would be about 324 points, or nearly 16%, lower if not for the progressive impact of share buybacks over the last seven years.

The actual impact of share buybacks over this period of time though would be less than that amount, because what we would really want to calculate is the impact of "surplus" share buybacks, which would be the difference between the number of share buybacks that have occurred with the number that would otherwise have occurred under "normal" economic and market conditions. And over the last several years, those conditions have been anything but normal, especially given what has been described as an "interesting coincidence" in how many companies came to have the cash needed to execute their share buyback plans in recent years.

Part of the reason for that cash hoard has been QE and near-zero interest rates, which have made it more attractive to take on debt to help fund share repurchases.
While there is no direct relationship between the two, the price tags on QE and buybacks offer an interesting coincidence: S&P 500 companies have spent about $2.41 trillion on buybacks over the course of the current bull market, according to S&P data, compared with a $2.37 trillion rise in the Fed’s balance sheet since the start of QE.

What does that mean for the market going forward? We'll let a JPMorgan analyst's comments from May 2013 (via ZeroHedge) explain:

"The other side effect of elevated dividends and share buybacks is that these distributions to shareholders may reduce the long term potential of the company to grow relative to the alternative of capital spending."

Two years later, that dynamic would be a major reason why the upward growth of the S&P 500 has largely stalled out through the first seven months of 2015, which through Friday, 24 July 2015, is less than 1% higher than it was at the end of 2014. It likely took longer than they expected, but scenario described by JPMorgan's analyst arrived all the same.

Data Sources

Standard and Poor. S&P 500 Buybacks Report. [Excel Spreadsheet]. Accessed 24 July 2015.

Standard and Poor. S&P 500 Earnings and Estimates. [Excel Spreadsheet]. Accessed 24 July 2015.

Update 28 July 2015: Readers should be aware that there are inherent flaws in treating the S&P 500 index as if it were a single company, where the analysis we presented above would only be applicable if it were. We'll have additional discussion on that topic sometime next week, but if you want a primer, see S&P's discussion of the math behind the index!