Category Archives: chaos

Closing out the Second Quarter of 2015 with the S&P 500

Reuters has sounded some dire news:

Wall St. tumbles as investors flee equities on Greek debt crisis

U.S. stocks fell sharply in heavy trading on Monday and the S&P 500 and the Dow had their worst day since October after a collapse in Greek bailout talks intensified fears that the country could be the first to exit the euro zone.

The European Central Bank froze funding to Greek banks, forcing Athens to shut banks for a week to keep them from collapsing.

And Greece appeared to confirm it was heading for a default after a government official said the country would not pay a 1.6 billon euro loan installment due to the International Monetary Fund on Tuesday.

U.S. investors also worried about Puerto Rico's debt problems and a bear market in China the day before quarter-end and ahead of Thursday's U.S. jobs report and the long weekend for U.S. Independence Day.

So are U.S. investors really "fleeing" the U.S. stock market based on the situation in Greece, Puerto Rico and China?

Well, if we look at what our standard model of how stock prices behave, we find that the level of stock prices is within the range of values we would reasonably expect them, whether U.S. investors were focused on either the third quarter of 2015, the fourth quarter of 2015 or the second quarter of 2016!

S&P 500 - Alternative Futures - 2015-Q2 - Standard Model - Snapshot 2015-06-29

That's really a consequence of how tightly compressed the expectations for the change in the year-over-year growth of dividends per share in each of these future quarters is at this time - there's really not that much difference between them at this point (although watch out below if investors suddenly focus on 2016-Q1!).

But more practically, if we had to pick one future quarter where the expectations associated with are currently driving the trajectory of the S&P 500, we'd go with 2015-Q3, for reasons not having anything to do with Greece, Puerto Rico or China, so the answer to that first question is... not so much.

Which will be nice while and as long as that lasts, but perhaps a better and more relevant question to ask at this point is how close is order to breaking down in the U.S. stock market?

Keeping in mind that the answer is presently rising at a rate of just under 1 point per trading day, the answer that applies the S&P 500's closing value of 2067.54 on 29 June 2015 is about 1.3%, or 27.4 points away from the key statistics-based threshold.

S&P 500 Daily Closing Value vs Trailing Year Dividends per Share, 30 June 2011 through 29 June 2015

More interesting is that its happening at nearly the four year anniversary of the last time order broke down in the U.S. stock market, after 30 June 2011, when the Federal Reserve's QE 2.0 bubble suddenly deflated.

S&P 500 Daily Closing Value vs Trailing Year Dividends per Share, December 1991 through June 2015

So will the period of order that began on 4 August 2011 finally break down after holding for four years? Well, if we consider each of the alternative trajectories for which we have sufficient data to project into the future using our standard forecasting model is any indication, the answer is... almost certainly yes.

S&P 500 - Alternative Futures - 2015 - Standard Model - Snapshot 2015-06-29

We've got about a month where we can continue to use our standard forecasting model for the S&P 500 in 2015, before we'll need to switch to our rebaselined model to work around the effects of the echoes resulting from last year's stock price volatility upon our standard model.

But this will likely be the last time we share what the alternative futures for the S&P 500 look like this year, as we'll have other things going on that will demand our attention.

The S&P 500 Finds Its Ceiling

We now have a handle on what the expected future for the S&P 500's dividends per share is through 2016-Q2. Our first chart shows the recent past history of how Standard and Poor has recorded each quarters dividends from 2013-Q1 through 2015-Q1, with the expected future dividends as recorded by the CBOE's dividend futures contracts as of 19 June 2015, the expiration date for the 2015-Q2 dividend futures contract:

Past and Expected Future Dividends per Share for the S&P 500, 2013-Q1 through 2016-Q2

Standard and Poor will report its dividends per share figure for 2015-Q2 after the end of the month.

The most important thing to take away from the dividend futures data presented in the chart above is that the rate at which dividends are expected to increase is decelerating. Which is the biggest factor behind why stock prices have mainly moved sideways to slightly higher in 2015 to date.

More interesting though is how quickly investors have shifted their forward looking focus since last week, when they were tightly focused on 2015-Q3 as they went about setting stock prices. In the last two days, they've moved their focus in stages to the more distant futures of 2015-Q4 and then 2016-Q2.

Alternative Futures for the S&P 500 - 2015Q2 - Standard Model - Snapshot 2015-06-19

And in making that last move, they've pretty much found the fundamental ceiling for the S&P 500, as the potential for continued upward movement through the end of June 2015 is limited to what we consider to be our typical margin of error.

That's not to say that stock prices couldn't move higher, but that would be consistent with what we would describe as a noise event, which would likely not be sustained in the absence of a significant improvement in the expectations for future dividends.

All noise events end. It's only ever a question of when.

Decoherent Expectations and the S&P 500

A week ago, we went to the very specific trouble of spelling out three very specific "what-if" scenarios for the trajectory that U.S. stock prices, as measured by the closing value of the S&P 500, would take during the week to be. Thanks to optimal forecasting conditions, one of those scenarios was almost perfectly dead on target.

Alternative Futures for S&P 500, 2015-Q2, Standard Model, Snapshot on 2015-06-19

The what-if scenario in question is the one where we projected what the S&P 500 would be if investors were to shift their forward-looking focus to 2015-Q3 in making their current day investment decisions. As for what made our forecasting conditions optimal, we have to thank the relative absence of noise in the market, where the Federal Reserve's Open Market Committee meeting provided the primary market news for the week.

That news was that economic conditions had improved since the first quarter of 2015, which investors interpreted as indicating that the Fed would be likely to act sooner rather than later to start hiking short term interest rates, which had become the dominant expectation on Monday, 15 June 2015. Although the Fed did not commit to a specific timetable or other details for its interest rate hiking plans, our standard model suggests that the stock market behaved in a way that is fully consistent with investors shifting their focus from 2015-Q4 in the previous week to instead fix their focus on 2015-Q3 and then holding it there through the end of the week.

So how come we couldn't have specifically forecast that specific trajectory? Why would we go to the very specific trouble of forecasting three separate likely trajectories for stock prices that differed only by how far in the future investors might focus their attention?

Well, as we keep saying, it is because stock prices obey the rules of quantum physics, where stock prices actually exist in a state of superposition, much like atoms and subatomic particles.

One mind-boggling consequence of quantum physics is that atoms and subatomic particles can actually exist in states known as "superpositions," meaning they could literally be located in two or more places at once, for instance, until "observed" — that is, until they interact with surrounding particles in some way. This concept is often illustrated using an analogy called Schrödinger's cat, in which a cat is both dead and alive until beheld.

Superpositions are very fragile. Once disturbed in some way, they collapse or "decohere" to just a single outcome.

For stock prices, the things that exist in superpositions are the expectations for the amount of cash dividends that will be paid out by specific points of time in the future, so we automatically have the situation where multiple expectations exist simultaneouly in the market. When investors observe, or in our terminology, "focus" upon a specific point of time in the future in response to new information as it becomes known, stock prices will collapse or decohere to a single outcome that is consistent with the expectations for dividends at the point of time they've focused upon within a relatively small margin of error - at least, given the amount of noise that typically exists in the market.

That situation applies when nearly all investors shift their attention to a single point of time in the future. There have been times when we've observed investors splitting their forward-looking attention between two separate points of time in the future, with stock prices falling between the "100% focused" trajectories our model forecasts, with stock prices being weighted accordingly with respect to the percentage split in investor focus.

As you might imagine, depending upon how different the expectations are for different points of time in the future, changes in stock prices that result from shifts in how far ahead in time that investors are focusing their attention can be very pronounced. Those shifts are a major contributor to volatility in the stock market when they occur and account for much of the apparently chaotic behavior of stock prices.

Knowing all that then, projecting the future trajectories of stock prices with some degree of accuracy is a complex proposition, but not a difficult one once you have the data that applies for each future point of time whose expectations for dividends are known. Anybody who can solve a simple quantum kinematics problem can do it.

The Economy Is Better, So Why Is the S&P 500 Slipping?

The single best measure of the relative state of the U.S. economy when it is experiencing some degree distress is perhaps the number of publicly-traded U.S. companies that announce they are cutting their dividends each month. Through 12 June 2015, that indicator suggests that the U.S. economy has taken a positive turn beginning in May 2015, which we can confirm because the cumulative number of dividend-cutting firms in the U.S. in the second quarter of 2015 is now coming in quite a bit lower than the pace that was established in the first quarter, which experienced negative GDP growth:

Cumulative Announced Dividend Cuts in U.S. Stock Market by Day of Quarter, 2015, Snapshot on 12 June 2015

But you wouldn't know that's the case from the U.S. stock market, which has basically been slipping sideways or only slightly moving higher throughout the whole second quarter of 2015:

Alternative Futures for the S&P 500 - 2015-Q2 - Standard Model - Snapshot on 12 June 2015

The reason why the market has been moving sideways has to do with the complex nature of how stock prices work (described in math here), but in a nutshell, the explanation is this - while the U.S. economy is indeed performing better than in the first quarter of 2015, it hasn't translated into a robust improvement in the outlook for cash dividends expected to be paid out in future quarters.

Instead, the change in the year-over-year growth rates for each of the future quarters for which we currently have data (2015-Q3, 2015-Q4 and 2016-Q1) is such that stock prices are such that when we translate those expectations into the likely trajectories that stock prices are likely to follow, we find that they are much more likely to either continue moving sideways or to fall than rise, with the actual trajectory dependent upon the future point in time to which investors fix their attention.

That forward-looking focus appears to have become highly correlated with the U.S. Federal Reserve's plans for hiking short-term interest rates in the U.S. Here, the timing of when that might begin to happen has become a key driver for U.S. stock prices.

At present, the dynamics of that factor are as follows:

  • For a hike in 2015-Q3, stock prices would initially dip a bit, before resuming a largely sideways trajectory in the short term (through the end of June). This scenario would correspond to the Federal Reserve coming to the conclusion that the U.S. economy is performing so strongly that it must act to begin cooling it off.
  • For a hike in 2015-Q4, stock prices would move sideways to slightly higher in the short term. This scenario would correspond to the Fed seeing a slower rate of improvement in the U.S. economy.
  • For a hike in 2016-Q1, stock prices would fall sharply before stabilizing at a level about 5% lower than the current level. This scenario would likely play out if the Federal Reserve comes to the conclusion that the outlook for the U.S. economy is likely to slow down from how it began performing in May 2015, and might also be influenced by external factors, such as Greece's looming debt default in Europe and its effect upon global markets.

The wild card in this is that we do not yet know what the expectations are for dividends in 2016-Q2. We'll know more about what the stock market future associated with that quarter sometime next week.

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.