Category Archives: chaos

Dividends: The Absence of Worse

According to Standard & Poor's Monthly Dividend Action Report [Excel Spreadsheet], in May 2015, 21 U.S. companies acted to cut their dividends. That's three more than did in April 2015 and a clear sign that recessionary conditions are still present in the U.S. economy.

Monthly Number of U.S. Publicly-Traded Firms Announcing Dividend Cuts, 2004-01 through 2015-04

For those who insist that winter weather was a significant factor dragging down the entire first quarter's GDP, or that the Bureau of Economic Analysis' seasonal adjustments for the first quarter in the U.S. are somehow responsible for that quarter's negative GDP figure, the number of dividend-cutting companies says otherwise. They also say that 2015-Q2 is shaping up to be better than 2015-Q1. And since we were virtually the only observer of the U.S. economy to correctly forecast that 2015-Q1's GDP would be recorded as negative, in large part because we pay attention to the number of companies that announce dividend cuts each month, that's probably something that so-called "Blue Chip" and Federal Reserve forecasters can stand to learn to do as well, if getting economic forecasts right is somehow important in any way.

What's more, they also say that the last two weeks have been the best weeks of 2015, by far. So good, in fact, that the cumulative number of U.S. companies cutting their dividends has fallen behind the pace that was being set in the first quarter of 2015.

Cumulative Number of U.S. Publicly-Traded Firms Announcing Dividend Cuts by Day of Quarter - 2015Q1 and 2015Q2, through 31 May 2015

That doesn't mean that the U.S. stock market is about to take off however. At present, it would appear that investors are progressively shifting their focus away from the current quarter of 2015-Q2 in setting stock prices to instead make their investment decisions in more and more accordance with the expectations associated with 2015-Q4, where most of that transition has occurred in the last week.

Alternative Futures for S&P 500 in 2015-Q2 - Standard Model - Snapshot Through 2015-06-01

That's understandable since that's fits the recent conventional wisdom that the Fed will wait until its December meeting to finally begin implementing its plan to start hiking short term interest rates. As you can see in our chart showing each of the alternate futures that stock prices might follow depending upon which point in the future that investors fix their attention, that transition is consistent with stock prices either moving sideways or slightly higher. Pretty much in keeping with what our forecast has been for the year to date.

Going back to the evidence of dividend cuts, what we see now is consistent with a U.S. economy on track to experience a sluggish-to-slow positive growth rate in 2015-Q2. As for where distress was to be found in the U.S. economy of May 2015, it predominantly remains small firms in the oil, gas and mining industries that are being most negatively impacted. Here is the full list we recorded from Seeking Alpha's Market Currents reports and the Wall Street Journal's Dividend Declarations reports.

Publicly Traded U.S. Companies Cutting Dividends in May 2015
Date Company Symbol Old Dividends per Share New Dividends per Share Percent Change
1-May-2015 Voya Prime Rate Trust PPR $0.02900 $0.02750 -5.2%
1-May-2015 AllianceBernstein AB $0.57000 $0.45000 -21.1%
4-May-2015 SandRidge Miss Tr II SDR $0.37500 $0.29000 -22.7%
4-May-2015 SandRidge Permian Trust PER $0.65600 $0.64000 -2.4%
6-May-2015 AmTrust Dep. Pfd. C AFSIC $0.47656 $0.44792 -6.0%
6-May-2015 Och-Ziff Capital Mgmt OZM $0.47000 $0.22000 -53.2%
6-May-2015 NVE NVEC $2.06000 $1.00000 -51.5%
7-May-2015 AuRico Gold AUQ $0.02360 $0.01000 -57.6%
8-May-2015 Apollo Global Mgmt A APO $0.86000 $0.33000 -61.6%
8-May-2015 Chesapeake Granite Wash CHKR $0.44960 $0.38990 -13.3%
8-May-2015 ECA Marcellus Trust I ECT $0.18000 $0.08400 -53.3%
8-May-2015 Ormat Technologies ORA $0.08000 $0.06000 -25.0%
8-May-2015 Sabine Royalty Tr UBI SBR $0.27658 $0.22925 -17.1%
8-May-2015 Terra Nitrogen TNH $2.50000 $2.08000 -16.8%
8-May-2015 Viper Engy Ptrs L.P. Un VNOM $0.25000 $0.19000 -24.0%
13-May-2015 National Bankshares NKSH $0.58000 $0.53000 -8.6%
13-May-2015 PPLUS FR Call Ser GSC-2 PYT $0.19167 $0.18125 -5.4%
18-May-2015 Marine Petroleum Trust MARPS $0.31009 $0.14480 -53.3%
19-May-2015 Cross Timbers Royalty Tr CRT $0.15696 $0.05237 -66.6%
19-May-2015 Permian Basin PBT $0.02378 $0.01567 -34.1%
21-May-2015 Dom Res Black Warrior Tr DOM $0.17455 $0.09875 -43.4%
21-May-2015 Mesa Royalty Tr MTR $0.07796 $0.05736 -26.4%
22-May-2015 China Yuchai CYD $1.20000 $1.10000 -8.3%

There are two trading entities who were recorded as having cut their dividends in May 2015 that likely were not included in S&P's official count: AmTrust Dep. Pfd. C, a preferred stock, and China Yuchai, a China-based company whose stock trades on the NYSE.

Noting those two "false positives", we believe we've fully captured all the firms that acted to cut their dividends in May 2015. And speaking of how good the last two weeks have been, no U.S. companies have announced dividend cuts since 21 May 2015.

Data Sources

Standard & Poor. Monthly Dividend Action Report. [Excel Spreadsheet]. Accessed 1 June 2015.

Seeking Alpha Market Currents. Filtered for Dividends. [Online Database]. Accessed 1 June 2015.

Wall Street Journal. Dividend Declarations. [Online Database]. Accessed 1 June 2015.

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.

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.

The Immediate Impact of the ECB’s QE on the US

From our perspective, the most important and useful part of the Efficient Markets Hypothesis (EMH) is its assumption that asset prices change quickly to reflect the impact of new information upon the future expectations of investors.

So what does the ability of investors to collectively and efficiently absorb and assess new information and to communicate the changes in their outlook through asset prices tell us about what the U.S. Federal Reserve is likely to do with respect to its plans to hike short term interest rates?

Well, if we go by how U.S. stock prices responded after the European Central Bank (ECB) announced its Quantitative Easing (QE) program on 22 January 2015, the immediate assessment of U.S. investors was that the Fed will most likely implement its rate hike plans sooner rather than later. We can see that shift in the sudden change in the trajectory of the S&P 500, where it has gone from following the trajectory associated with an investor focus on 2015-Q4, which is consistent with what had been the growing consensus that the Fed would delay its rate hikes until then, to the nearer-term future associated with a forward-looking focus on 2015-Q2, which investors would now appear to consider to be more likely.

Shift in S&P 500 Stock Prices from 2015-Q4 Trajectory to 2015-Q2 Trajectory on 22 January 2015 following ECB Announcement of QE

That assessment will most likely be confirmed after the Federal Reserve's Open Market Committee concludes a two-day meeting on Wednesday, 28 January 2015 and issues a new policy statement. The Wall Street Journal explains why investor expectations would change in response to the ECB's decision in its schedule of economic news events for the week.

U.S.: 2:00 p.m. EST. Federal Open Market Committee’s monetary policy announcement:

After the ECB’s bombshell news of last week, all eyes now turn to the Fed. If it signals its continued intent to raise rates in the months ahead, this will likely drive even more fund flows into the dollar. How the Fed views that ECB move will be key. If it interprets it as an effective move to restore growth in the eurozone, it will see it as constructive to U.S. growth and likely want to stay the course and move toward higher rates sometime in the last spring or summer. If it instead focuses on the surge in the dollar that has come from the ECB move, it could be inclined toward holding back because of the disinflationary effect of that.

We already know that the Fed pays very close attention to the stock market in weighing their future actions, which we observed previously during their own QE programs. The reaction of the U.S. stock market to the ECB's action to initiate a QE program for the EU is such that the Fed is likely to hike short term interest rates in the US above their current 0-0.25% range by the end of 2015-Q2.

And that will hold until newer information might force the Fed to adapt its plans.

A Particular Kind of Luck

In the process of testing out and selecting a new color scheme for displaying complex data on a Microsoft Excel chart, we somehow managed to accurately forecast the overall trajectory of stock prices last week. Over a week in advance.

Here's how we did that. The complex data we were displaying was generated from our standard model of how stock prices work, which combines future-oriented data related to the amount of dividends expected in future quarters with historic stock prices, which our model uses as base reference points for projecting stock prices into the future.

Specifically, our standard model for forecasting stock prices incorporates the historic value of the S&P 500 from 13 months earlier, 12 months earlier and one month earlier in projecting a particular day's most likely stock prices. The chart below shows the trajectories for each that apply in 2015 (the heavy black line represents current day stock prices).

S&P 500 Index Value (Historic Data Base Reference Points) Used in Standard Model Forecast Projections, 2015

If you pay close attention to our chart, you'll find that the current day S&P 500 is almost perfectly following the trajectory that stock prices did exactly one month earlier, when investors were weighing the potential negative impact of falling oil prices on the growth prospects upon the U.S. stock market in the future. That dynamic is what our model has picked up upon.

The fact that it would appear to be repeating is a phenomenon that's largely driven by the U.S. bond market. Our thinking is that the investment decisions that were made in December 2014 are being repeated again in January 2014 with the maturation of one-month U.S. Treasuries. It's kind of like an aftershock after an earthquake, or in this case, a noise event in the U.S. stock market, where a past event is actually driving stock prices in the current day, to the extent that such an event can.

The degree to which events in the past might drive today's aftershocks or to more often dissipate as yesterday's echoes would really appear to depend greatly upon what investors expect for the future as the maturity and option expiration dates associated with their previous investment choices come to pass and provide the means for executing new decisions. If the future doesn't change in the interim, why should the investment decisions of investors change?

So it's actually luck that is behind that our model's ability to have accurately projected the trajectory that stock prices followed last week. It's just fun to see that it's possible to build a particular kind of luck into a mathematical model!