Archive for June, 2013

S&P 500 P/E’s versus 10-Yr Treasury Rates From 1957

Saturday, June 22nd, 2013

In our recent post, we used historical mean reversion to estimate the Fed’s target rate for 10-year Treasuries, 30-year mortgages, and Baa corporate bonds, based on the Fed’s 2% inflation target.  One commenter wrote to us and asked what that implied for the S&P 500 P/E ratios.

We looked at the monthly history of trailing P/E ratios for the S&P 500 since its inception in March 1957, and conclude that there is no useful rule of thumb about P/E ratios and interest rates in the interest rate range from 4% to 6%.  At much higher interest rates, P/E’s do become depressed;  which relates the to business stifling aspects of very high rates.  However, the 4% to 6% range, which is what we may face in next year or two, has not historically been a problem.

P/E ratios, we believe, have much more to do with expected earnings growth rates, which we will examine historically in a subsequent post.

For those who argue that businesses today could not cope with 4% to 6% interest rates, they would expect multiple contraction.  However, for those who believe that 4% to 6% rates could be handled in a growth economy, this data gives no reason to expect multiple contraction.

To attempt to dispose of the P/E versus interest rate question, here are two charts — one with no cap on the P/E, and another with a 30x cap on the P/E  to “open up” the tight cluster areas of the chart.

(click images to enlarge)




The charts have linear regression trend lines applied, but the fit (R-squared value) is weak.  The huge scatter is clear on both charts.

The current situation with an approximate 14.5x 2013 estimated operating P/E, 18.4X trailing “as reported” P/E, and an approximate 2.5% 10-year Treasury yield is positioned in the low end of P/E ratios for the current interest rate. The current P/E, based on this history, could be maintained at higher interest rates without getting out of the historical range.

The red lines plot the current S&P and Treasury status. The blue shading highlights the P/E ratios that have occurred when 10-year Treasuries had interest rates between 4% and 6% — the general nominal rate range we believe the Fed is targeting.

To our commenter, P/E ratios are not correlated with interest rates.

Our view is conventional: If higher interest rates correspond to an improving economy, earnings may be improving which would support the current or even higher P/E ratios; and that if higher interest rates caused earnings to decline, then multiples would be reduced causing stock prices to decline.

We will look at forward earnings and dividend yield versus interest rates in subsequent posts.



Emerging Markets Index In Bear Territory Now

Thursday, June 20th, 2013

The MSCI emerging markets index has reached bear market territory (20% below trailing 1-year high).  Of the top 10 countries in the index, only 2 are not in bear territory. The other 8 are in bear markets.

(click images to enlarge)


Top 10 Country Holdings:

EEM holdings

These two are down, but not near bear territory:





These 8 countries are all in bear territory:


China has been in bear territory since mid-2011.  One could debate whether they got out of bear territory in early 2013.  They are well below the 2013 trailing high, but not yet 20% below that level.  However, in the context to price since 2011, we call the price a continuation of the long running bear.




South Korea


South Africa













S&P 500 Total Return vs. Price Return: 20, 10, 5 and 1 Years

Monday, June 17th, 2013

(click images to enlarge)


Markets Snapshot June 14, 2013

Sunday, June 16th, 2013

These 28 charts covering 46 key asset categories give a year-to-date and a 3-month view of relative dividend adjusted price performance for those categories, in each case compared to the S&P 500 as the benchmark.

Summary observations:

  • the S&P 500 is not at correction level (down about 2.4% from high)
  • emerging markets are correction territory
  • China and Brazil in specific are in correction
  • developed non-US markets are approaching correction territory
  • Japan is in correction after a recent rapid rise
  • frontier markets are doing as well as the S&P 500
  • US dividend stocks are performing similarly to the S&P 500
  • healthcare, cyclicals and financials are the strongest sectors
  • utilities are the weakest sector, but not quite yet in correction territory
  • equity REITs have entered correction territory
  • lumber and copper are in correction
  • gold and silver are in correction
  • bonds are down by amounts similar to their annual yield
  • floating rate bank loans are outperforming fixed rate high yield bonds

The US equity market overall continues to be doing best.



Don’t Accept BuyBack Yield Argument Without Substantial Caveat

Friday, June 14th, 2013

BuyBack Yield is an interesting concept, and a useful tool as part of stock analysis.  However, it SHOULD NOT be used as a security selection or rejection criterion without interpretation with other data.    What seems good could be bad, and what seems bad could be good.

There are some advisors talking up BuyBack Yield as if it is some kind of new magic bullet for yield seekers.  Well we think it ain’t so.

It is a good idea for yield seekers to look for as much supplemental evidence of strength and shareholder reward as possible, and BuyBack Yield has a role in some cases as a preliminary indicator.  However, BuyBack Yield can just as easily mislead you as point you in the right direction unless it is accompanied by careful consideration of other fundamentals, as well as industry and company specifics.

BuyBack Yield simply measures the percentage change in outstanding shares over a period of time.

The argument for BuyBack Yield is that if a company is using earnings to purchase its own shares, it is concentrating earnings — in effect yielding earnings to shareholders more efficiently than shareholders could do by receiving dividends, paying taxes on them and then purchasing more of the company’s stock.

For dividend paying companies, a combination of dividends received and earnings accretion due to share buybacks creates an extra dose of value creation.  That is an appealing argument for what some call “Total Yield” (BuyBack Yield + Dividend Yield).

Certainly the idea warrants measuring BuyBack Yield and Total Yield, but the data must be taken into context to avoid undue positive or negative views of a stock, and to avoid ranking stocks by Total Yield in a way that is misleading.

How Might BuyBack Yield and Total Yield Be Misleading?

  • If a company issues shares to acquire another company, even if the acquisition is accretive to earnings, the BuyBack Yield is negative and the Total Yield is reduced and may be negative.  That would be misleading, unless you are simply opposed to acquisitions.
  • If a company issues shares to investors to raise more capital when the stock price is high, and the new capital is to be used for CapEx for business expansion, the BuyBack Yield is negative, but the implication may be positive.
  • If a company reduces its outstanding shares by a repurchase program when the stock valuation multiple is high, the BuyBack Yield is positive, but if the valuation multiple is unreasonably high and likely in your view to revert to a lower multiple, then that positive BuyBack calculation would be a false indication of a positive effect
  • If a company reduces its outstanding shares with a repurchase program, but at the same time awards executives boat loads of stock options, the intermediate-term to long-term value of the BuyBack Yield calculation could be very much in question
  • Companies that step in with both feet to buy shares in a down market are often making a good choice, but the short-term BuyBack Yield at that time cannot reasonably be projected into the future, and long-term average BuyBack Yield may be distorted by a recent spike in share purchases due to a market downturn.
  • BuyBack Yield based on the past 12 months (as is the case with the NASDAQ BuyBack Index) is far less useful than dividend yield as a long-term yield indicator, because share repurchase programs are often highly variable from year-to-year, whereas dividends have a far greater tendency to be carefully managed for consistency and growth.

You may be able to think of other examples.  The point is that dividends are what they are — cash in your hand, but BuyBack Yield may or may not be as good or as negative as a simple calculation and/or ranking would suggest.

We think BuyBack Yield is an interesting and useful tool, but one that must be taken in context of more information about why and how the BuyBack Yield came about.  We think just looking at the 12-month BuyBack Yield is particularly dangerous for yield seekers, and instead or in addition investors should also look at multi-year average BuyBack Yields.


We identified the 135 stocks available in the USA as of 06/07/2013 with 3% or more in trailing yield, and 3% or more in dividend growth over the last 4 quarters, and also on average over 1, 2, 5 and 5 fiscal years.  Within than universe, we looked at 12-month and 5-year BuyBack Yield.

Seagate Technology (STX) has the highest 12-month BuyBack Yield at 19.7%, bringing the Total Yield to 23.2%.  But its 5-year BuyBack Yield is only 5.2% — still a nice number, but no where near 19.7%.

We would suggest a Total Yield of 8.7% is more reasonable than 23.2% for STX.  We have not research the why or how their repurchases took place, but with this data simply illustrate the importance of taking a longer view of share repurchase behavior.

Here is a chart from showing their trailing BuyBack Yield and dividend yield for the last 10-years — you can see the comparative irregularity of the BuyBack Yield versus the dividend yield:


Along the same lines, Vodafone (VOD), which has a 5.3% dividend yield, has a 5.8% 12-month BuyBack Yield, but only a 1.5% 5-year BuyBack Yield.

On the other side of the question, Raytheon (RTN) has a 3% 12-month BuyBack Yield and a 5.3% 5-year BuyBack Yield.

Again, we have not researched the acquisition, CapEx, R&D, or options granting behavior of these companies; but we think the raw data shows the high variability of BuyBack Yield data over different time periods. That argues against the 12-month approach for long-term views, in our opinion.

Some companies that appear to show good consistency, such as Chevron (CVX), which has a 1.8% 12-month BuyBack Yield, and a 1.6% 5-year BuyBack Yield have nonetheless significant variability on a period-to-period basis, while their dividend yield shows comparatively high consistency.


What about companies with large negative BuyBack Yields?  We don’t think it tells you that much with capital intensive companies.

Take Northeast Utilities (NU) for example.  They have a negative 77% 12-month BuyBack Yield, and a negative 14.1% 5-year BuyBack Yield, and a 3.5% dividend yield.  Assigning a negative 73.5% or negative 10.6% Total Yield to them seems rather useless.  By the nature of the industry, their BuyBack Yields would tend to be negative.

Of the 18 Utilities in the 135 stocks in our sample, only 3 have positive 12-month and 5-year BuyBack Yields.  Maybe they are doing well, or maybe they have declining demand, or are deferring CapEx. We would have to look into that, and in fact intend to do so; but overall utilities and BuyBack Yield may not go together well.

Those three positive BuyBack Yield utilities are: Wisconsin Energy Corporation (WEC), Alliant Energy Corporation (LNT) and Dominion Resources (D).  Their 10-year BuyBack Yields are shown in this chart:


There is a slight difference in the data in our source database and the one used by YCharts, but the numbers are close enough for illustrative purposes.  Different databases almost always have some differences, and virtually all databases contain some errors, so don’t get too lathered up about small discrepancies, and before making final decisions check original sources.

Another interesting example is Enterprise Products Partners LP (EPD), the largest pipeline MLP.

Their dividend yield is about 4.4%. Their 12-month BuyBack Yield is positive 0.8%, but their 5-year BuyBack Yield is negative 38.4%.  Which would you use for Total Yield?

We wouldn’t use either one, because MLPs payout most of their cash flow and must either issue more shares or borrow more money to expand.  Eventually there are borrowing limits, and parent entities might typically take shares for asset “drop downs” into MLPs.  In any event, we don’t think BuyBack Yield is useful for companies like this.


The same may be true for REITs.  Consider Digital Realty Trust (DLR), with a  negative 18.1% 12-month and negative 13.9% 5-year BuyBack Yield.  Equity REITs payout most of their cash flow and need to borrow or issue shares to expand.


There are companies, though, where BuyBack Yield does make sense to us, and may help identify better opportunities.  Kimberly Clark (KMB), GlaxoSmithKline (GSK) and McDonalds (MCD), may be examples.  They have been reasonably consistent in their repurchases, but also stepped in big during the 2008 crash when they could buy earnings cheaply.



There is an ETF that focuses on the NASDAQ BuyBack Achievers index (based on trailing 12-months of outstanding shares data) PowerShares BuyBack Achievers Portfolio (PKW).  It has done very well, beating the S&P 500 (SPY) and the S&P 1500 High Yield Dividend Aristocrats (SDY).

That does not however, mean that BuyBack Yield is an effective universal tool to evaluate effective Total Yield to shareholders.  What it means is that recent strong share repurchases correspond to near-term subsequent price increases.  We give that approach full kudos, but we caution not to extrapolate that phenomenon to the yield seeking goal.  They are two different things.

To be eligible for inclusion in the index, a stock must have repurchased at least 5% of its outstanding shares in the past 12 months.  The index is rebalanced quarterly.

Here is price performance.  PKW wins.


Here is the rate of change of dividend payment amounts for the ETFs.  The share repurchase criterion does not correspond to a superior rising dividend.



We recommend looking at BuyBack Yield as part of your stock evaluation process, but also looking past BuyBack Yield as to why and how it cam about before relying upon it as a yield seeking investor.



High and Low Quality Stocks Beat the S&P 500

Wednesday, June 12th, 2013

High quality and low quality stock performance rotate in the short-term, and they both beat the S&P 500.

High quality stocks generally do better in down markets or periods of uncertainty or pessimism.  Low quality stocks generally do better in up markets or periods of greater clarity or optimism.

Higher quality stocks have better risk adjusted returns, higher yields and better dividend growth.

Standard & Poor’s said this in their July 2010 report, “Is High Quality Always Better?”, which studied the high and low quality sub-indexes of the S&P 500 index:

“The quality premium, or difference in return of high quality versus low quality, is positive in down markets. Conversely, in up markets the quality premium turns negative.

The quality premium is a function of risk aversion, credit spread, and changes in the slope of the yield curve. During periods of high volatility, widening credit spread, and steepening yield curve, the quality premium tends to be positive.

Conversely, in periods of declining risk, narrowing credit spreads, and flattening yield curves, the quality premium tends to be negative.

… we suggest viewing quality in the same light as style, size, and sector exposures or, in other words, as subject to rotations in various market environments.”

The high quality sub-index includes those stocks ranked A+, A and A-.  The low quality sub-index included those stocks ranked B, B-, C.  Stocks ranked average at B+ and those ranked D or in liquidation are in neither sub-index.  The sub-indexes are quality ranked — the higher quality stocks are more heavily weighted in the high quality sub-index, and the lower quality stocks are more heavily weighted in the low quality sub-index.

Down and Up Stock Market: In their study of the relative performance of high and low quality from May 31, 1997 through May 31. 2010, they found that in down quarters, the total return of the high quality sub-index exceeded that of the low quality sub-index by 1.22%, but in up market quarters the higher quality sub-index underperformed by 0.75%.

Widening and Narrowing Credit Spread:  During that period, they found that in quarters where the rate spread between the US aggregate corporate investment grade index and the US 10-year Treasuries is widening, high quality outperformed by 1.59%, and when the spread was narrowing, high quality underperformed by 0.42%.

Rising and Declining Volatility:  They  found that in quarter with rising volatility as measured by the CBOE VIX, high quality outperformed by 2.23%, and when the VIX declined, high quality underperformed by 0.86%.

Steepening and Flattening Yield Curve: They defined the yield curve in terms of the rate spread between the 2-year and 20-year US Treasury rate; and defined steepening as an increase of 50 basis points or more, and flattening as a decrease of 50 basis points or more.  They found that in steepening quarters high yield outperformed by 1.62%, and in flattening it underperformed by 0.15%

Cumulative Total Return Differences: The surprising data about the quality indexes, is that both the high quality and low quality sub-indexes outperformed the complete S&P 500 index.  This chart and table from the Fact Sheet on their website for the high quality sub-index shows that.

(click image to enlarge)


Over the 10 years from 2000 to 2010, the low quality sub-index just barely squeaked out a win over high quality, but low quality was behind more than 1/2 the time.  Low quality had a higher volatility, but a somewhat better risk/reward as measured by the Sharpe Ratio.

Price Return Differences Since 2010:

We did our own measure of the price return difference since 04/19/2010 (first data where all data available to us) through 06/11/2013.

Again both high and low quality outperformed the total S&P 500 index, but in this period high quality slightly outperformed low quality.

Specifically, the ending prices were higher than the beginning prices as follows:

  • High quality (.SPXQRUP) +45.08%
  • Low quality (.SPXQRLUP) + 42.12%
  • Total S&P 500 (.SPX) +35.91%

The symbols shown are the Reuters symbols for the indexes.

Recent Relative Performance:

This chart using the Reuters symbols shows the relative performance of the prices of the high and low quality indexes since early 2010.  The data is normalized to the beginning set at zero.

The chart shows the ratio of the high quality price divided by the low quality price on a day-by-day basis from 04/19/2010 to 06/11/2013.

(click image to enlarge)


You can see the rapid improvement in high quality in the second half of 2011 when there was lots of panic over Europe; and you can see the decline in high quality relative performance in the second half of 2012 into 2013 as the overall stock market has been rising.

This chart for the same time period, shows the price of the high quality index divided by the price of the full S&P 500 index.

(click image to enlarge)


Consistent with data from Standard and Poor’s for the 2000 to 2010 period, high quality outperformed the full S&P 500 index.

Not shown, but clear from the tabular and chart data above, low quality also outperformed the full S&P 500 index.

A Granular View By Quality Rank:

We examined the price performance, standard deviation, Beta, yield and dividend growth rate for 3,116 stocks rated for quality by Standard and Poor’s, that also had at least 3 years of data available.  Let’s look at that data which goes well beyond the S&P 500 universe.

The S&P indexes are weighted according to quality.  Our study below treats each stock equally.

Number of Stocks By Quality Rank:


There are a lot more low quality than high quality stocks.  Less than 10% are high quality. Standard and Poor’s ranks more stocks than that, but not all had sufficient data in our source to be included here.

Short-Term Price Return By Quality Rank:


Consistent with the 3-year relative performance chart above, the lower quality stocks have been outperforming over 1 year and 6 months generally, but the mid-high quality “A” rated stocks have been relatively strong on a spotty basis.

3-Year Volatility and Risk Reward:


The lower, low quality stocks have outperformed on a price basis over 3 years, however the higher the quality the lower the volatility as measured by both standard deviation and Beta.

The risk adjusted price return, as measured by 3-year annualized price rate of change divided by 3-year annualized standard deviation, is uniformly better the higher the quality.  The same is true when price return is adjusted by the Beta with the exception of the “C” rated stocks — but you have to be a big speculator to go to “C” rated stocks to seek opportunity, and can expect a very exciting volatility ride.

Yield and Dividend Growth:

(click image to enlarge)


The 1-year buyback yield (based on change in shares outstanding) is definitively higher for high quality stocks, and definitively negative for low quality stocks.  The dividend yield is higher among the high quality stocks than the low quality stocks; and the sum of the dividend yield and buyback yield of the high quality stocks is better than the low quality stocks.

The average and upper-end low quality stocks had the highest 1-year dividend growth rate — probably a sign of an improving economy and increase management optimism allowing stocks with below average yields to play some catch-up.  Otherwise the higher the quality the higher the 3-year, 5-year and 7-year dividend growth rate.

The 43 Stocks In The A+ Category In Our Study:

(AAN) Aaron’s Inc. Com
(BAX) Baxter Internatio
(CASY) Caseys General St
(CAT) Caterpillar Inc.
(CHD) Church & Dwight C
(CHRW) C.H. Robinson Wor
(CL) Colgate-Palmolive
(CVS) CVS Caremark Corp
(CVX) Chevron Corporati
(DCI) Donaldson Company
(DHR) Danaher Corporati
(DIS) Walt Disney Compa
(ECL) Ecolab Inc. Commo
(EMR) Emerson Electric
(FDO) Family Dollar Sto
(GWW) W.W. Grainger In
(HRL) Hormel Foods Corp
(IBM) International Bus
(IMO) Imperial Oil Limi
(INT) World Fuel Servic
(JKHY) Jack Henry & Asso
(JNJ) Johnson & Johnson
(K) Kellogg Company C
(KO) Coca-Cola Company
(LLL) L-3 Communication
(LO) Lorillard Inc Co
(MKC) McCormick & Compa
(MMM) 3M Company Common
(NKE) Nike Inc. Common
(NKSH) National Bankshar
(OMC) Omnicom Group Inc
(PG) Procter & Gamble
(PX) Praxair Inc. Com
(ROST) Ross Stores Inc.
(SIAL) Sigma-Aldrich Cor
(SYK) Stryker Corporati
(SYY) Sysco Corporation
(TGT) Target Corporatio
(TJX) TJX Companies In
(UNH) UnitedHealth Grou
(UTX) United Technologi
(WMT) Wal-Mart Stores
(XOM) Exxon Mobil Corpo
(YUM) Yum! Brands Inc.

The 94 Stocks In The A Category In Our Study:

Brown-Forman, HEICO, Hubell and John Wiley are also rated “A”, but were not included in the study because we forgot to change the symbol from X-A or X-B to X/A or X/B as we moved between data bases.  We do not believe the results are materially impacted by their omission.

(AAP) Advance Auto Part
(ABC) AmerisourceBergen
(ABT) Abbott Laboratori
(ADP) Automatic Data Pr
(AIT) Applied Industria
(APD) Air Products and
(ATNI) Atlantic Tele-Net
(ATR) AptarGroup Inc.
(BCPC) Balchem Corporati
(BCR) C.R. Bard Inc. C
(BDX) Becton Dickinson
(BHB) Bar Harbor Banksh
(BLL) Ball Corporation
(BNS) Bank Nova Scotia
(BRO) Brown & Brown In
(CASS) Cass Information
(CB) Chubb Corporation
(CFR) Cullen/Frost Bank
(CHE) Chemed Corp
(CLX) Clorox Company (T
(CNI) Canadian National
(COL) Rockwell Collins
(COST) Costco Wholesale
(CPK) Chesapeake Utilit
(CRR) Carbo Ceramics I
(CSX) CSX Corporation C
(DE) Deere & Company C
(DOV) Dover Corporation
(DRI) Darden Restaurant
(EGN) Energen Corporati
(ENB) Enbridge Inc Comm
(ETR) Entergy Corporati
(EXPD) Expeditors Intern
(FAST) Fastenal Company
(FDS) FactSet Research
(FFIN) First Financial B
(FLIC) The First of Long
(GAS) AGL Resources In
(GD) General Dynamics
(GIS) General Mills In
(GPC) Genuine Parts Com
(HAS) Hasbro Inc.
(HBNC) Horizon Bancorp (
(HCC) HCC Insurance Hol
(HD) Home Depot Inc.
(HEI) Heico Corporation
(INGR) Ingredion Incorpo
(IPAR) Inter Parfums In
(ITW) Illinois Tool Wor
(JWN) Nordstrom Inc. C
(KMB) Kimberly-Clark Co
(LKFN) Lakeland Financia
(LMT) Lockheed Martin C
(MCD) McDonald’s Corpor
(MDT) Medtronic Inc. Co
(NEE) NextEra Energy I
(NOC) Northrop Grumman
(NSC) Norfolk Southern
(NWFL) Norwood Financial
(OMI) Owens & Minor In
(OZRK) Bank of the Ozark
(PAYX) Paychex Inc.
(PB) Prosperity Bancsh
(PEI) Pennsylvania Real
(PEP) Pepsico Inc. Com
(PETM) PetSmart Inc
(PH) Parker-Hannifin C
(PNY) Piedmont Natural
(RBC) Regal Beloit Corp
(RGA) Reinsurance Group
(RL) Ralph Lauren Corp
(ROL) Rollins Inc. Com
(ROP) Roper Industries
(RTN) Raytheon Company
(SHW) Sherwin-Williams
(SJM) J.M. Smucker Comp
(SNA) Snap-On Incorpora
(SYBT) S.Y. Bancorp Inc
(TMK) Torchmark Corpora
(TUP) Tupperware Brands
(UMBF) UMB Financial Cor
(UNP) Union Pacific Cor
(VFC) V.F. Corporation
(VMI) Valmont Industrie
(VSEC) VSE Corporation
(WAB) Westinghouse Air
(WAG) Walgreen Co. Comm
(WEC) Wisconsin Energy
(WTR) Aqua America Inc
(WWD) Woodward Inc.
(YORW) The York Water Co

The Bottom Line:

The data is clear — high quality is more desirable than the full S&P 500 index.  High quality is more desirable than low quality if volatility, yield and yield growth are an issue.

There is no low quality S&P 500 fund that we are aware of, and it wouldn’t interest us if there was one.

There is a high quality S&P 500 fund (SPHQ) and it does interest us; however it has low volume (13,000 shares by mid-day today), while the S&P 500 ETF (SPY) has massive volume (77 million shares by mid-day today).  Liquidity for many to most accounts makes any wholesale shift to SPHQ impractical.  However, making sure that individual stocks are in the higher quality ranks is possible, and is a focus item for us

Given that the US economy is strong and the rest of the world is comparatively weak, high quality stocks with big international exposures [such as Caterpillar (CAT)] are not as attractive short-term, but are probably more attractive long-term as they capture revenue in developing economies, and their prices recover.  A balance of each is probably a good idea now, depending on the time-frame and withdrawal needs of individual accounts.