Yield hunting in the Dogs of the Dow

Investing in the Dogs of the Dow as a strategy dates back to 1991 from a book “Beating the Dow” by Michael O’Higgins. The Dogs of the Dow are the 10 highest dividend yielding stocks within the Dow 30. They are called investment “Dogs” because rising dividend yields tend to be a function of falling prices.

It is a simple strategy of allocating an equal amount of funds into each of these 10 stocks and holding them for a year. Normally, an investor would need to only rid about two to three stocks every year and replace them with different ones. These stocks are typically replaced because their dividend yields have fallen out of the top 10 because the stock price has either increased in value or have reduced their dividend payment. (Sometimes a stock, like GE that has fallen on hard times is removed from the DJIA altogether.)

Why am I hunting for yield in the Dogs of the Dow

• My retirement accounts contain a large percentage of  U.S. dollar holdings.
• I am a retired Canadian senior who requires income from my investments to pay bills.
• Dividend stocks provide income and some downward protection during volatile markets.
• Historically, Dow stocks have been very stable companies that can weather any market decline with their solid balance sheets and strong fundamentals.
• The current yield on the dogs of the Dow are higher than the yield on 2 & 10 year U.S. treasuries
• The Canadian dollar is currently trading at a 32% discount to the U.S. dollar which increases the income from holding U.S. stocks.

Dogs of the Dow 2019

Stock Symbol	Company Name	2018 Close	Dividend Yield
IBM	International Business Machines	113.67	5.52%
XOM	Exxon Mobil	68.19	4.81%
VZ	Verizon Communications	56.22	4.29%
CVX	Chevron	108.79	4.12%
PFE	Pfizer	43.65	3.30%
KO	Coca-Cola	47.35	3.29%
JPM	JP Morgan Chase	97.62	3.28%
PG	Procter & Gamble	91.92	3.12%
CSCO	Cisco Systems	43.33	3.05%
MRK	Merck	76.41	2.88%

At first glance, IBM has a very tempting dividend yield. However, I warned my readers that IBM wasn’t a good investment back in 2015 when Warren Buffett lost 11.8% on his IBM shares. Buffett has sold all his IBM shares for an estimated 2 billion dollar lost. The trend has been downward ever since and I don’t see a turn around anytime soon.

Warren Buffett looses $500 million on IBM’s Bad Quarterly Results

Oil stocks have been very volatile due to slower world economic growth, over-supply concerns and fears of a 2020 recession. I am eliminating  both Chevron and Exxon Mobil as potential buys.

I am using fundamentals to eliminate Coca- Cola, Merck and P&G because of their high price earnings ratios compared to the rest of the stock market. Plus, Coco-Cola and Merck have high dividend payout ratios which will make it difficult for them to increase dividend payouts going forward.

J.P. Morgan has never been a Dog of the Dow until this year. U.S. banks have seen their net interest margins decrease due a flattening  yield curve. In simple terms, they are paying more interest on deposits but loan demand is weak so they are getting less loan interest. U.S. banks have under performed the over all market. This is a possible turnaround candidate if economic growth comes in stronger than expected.

Verizon and Pfizer have been Dogs of the Dow for the past five years and have fairly good fundamentals. They both have stable share prices, low payout ratios and reasonable price earnings ratios. These two stocks are possible buys for income.

Dec. 2018	Verizon	$52.93	4.46%	Pfizer	$36.22	3.75%
Dec. 2017	Verizon	$53.38	4.33%	Pfizer	$32.48	3.94%
Dec. 2016	Verizon	$46.22	4.89%	Pfizer	$32.28	3.72%
Dec. 2015	Verizon	$46.78	4.70%	Pfizer	$31.15	3.60%
Dec. 2014	Verizon	$49.14	4.31%	Pfizer	$30.63	3.40%

I think that Cisco is strong buy. Cisco has been a Dog of the Dow for the past 4 years and their share price continues to increase in value. During those years, Cisco has maintain a consistent 3% dividend yield by increasing their annual dividend.

Dec. 2018	Cisco	38.3	3.03%
Dec. 2017	Cisco	30.22	3.44%
Dec. 2016	Cisco	27.16	3.09%
Dec. 2015	Cisco	22.43	3.03%

Unfortunately, past performance is no guarantee of future returns. Please do your own research, this post is for educational purposes only!

 

What money lessons did you learn from your father?

To say that my relationship with my father was complex would be an understatement. I can’t imagine leaving Canada, going to a foreign country with no marketable skills, not being able to read, write or speak the language. That is exactly what my father did when he left war torn Italy back in 1952. A whole new meaning to “desperate times calls for desperate measures.”

Lesson one: Higher education can lead to better paying jobs

My father had very little formal education and at the age of 12, he left school to work the family farm. It is no wonder that I received many lectures on the value of a good education. It didn’t matter that I used to argue that some university courses didn’t really prepare young people for the working world. His reply was always the same. “You need that piece of paper” (a university degree)

We were both right, the university degree did help me to get my first job but I still had to go through a rigorous company training program. The university courses that I took had very little to do with my career.

Lesson two: The difference between needs and wants

There is no doubt that growing up in a low income environment taught me the difference between what I needed and what I wanted. Watching my dad stretch his paycheck to provide the bare necessaries in life was a real eye opener. It has stuck with me ever since and I still avoid spending money for luxury items.

Lesson three: Own the roof over your head

I am amazed that within six years my parents who were illiterate, with no education, manage to save enough money to buy a house. They earned extra income by renting a portion of our house for over ten years to assist with the mortgage payments. My mother still lives in that house and because it is located in Toronto, it could be worth close to one million dollars today.

Lesson four: Never spent money that you don’t have

My dad never owned a credit card. He paid for everything with cash or check.  A few times he did borrow some money from relatives to buy a new car or for medical bills before there was government paid health care. I know that my broken leg put some extra strain on the family’s finances when I was very young.

What my dad couldn’t teach me

Saving for retirement and how to invest your money

Being uneducated, he didn’t know that income from government pension plans would only cover a small portion of his living expenses in retirement. Despite his frugal life style, he would have had to sell the house at much lower prices than today. His untimely death and an inheritance from my mother’s parents has delayed the selling of the house for the past 25 years.

Happy Father’s Day!

Pass on what you know to your children!

 

 

 

A few suggestions on how to invest a $300,000 inheritance

Last week’s post contained a real life Canadian couple’s financial dilemma on how to invest a surprised inheritance. I asked writers and readers of financial blogs to email me their suggestions. This couple is in their mid-fifties and are hoping to retire in 8 to 10 years. They are debt free, have poor paying jobs and only managed to save $55,000 for retirement. Unfortunately, my bullet point list of Canadian tax info wasn’t very clear.

Additional clarification of  the Canadian Tax system

Canadians have three choices for saving for retirement if they don’t have a company pension.

Registered Retirement Saving Plan (RRSP)

• Contributions are limited to 18% of working income (max. $25,370 investment income not included)
• Tax deductible, refund based on your tax rate (lowest 20%, highest is 53%)
• Tax free compounding, withdrawals are 100% taxable at your personal tax rate (lowest 20%, highest is 53%)
• Government requires you to make withdrawals at age 72
• Not usually recommended for low income families

Tax free Savings Account (TFSA began in 2009), geared to low income families

• Personal contributions are limited to $5,500 per year, not tax deductible
• Unused contributions are carried forward indefinitely
• Tax free compounding, withdrawals are not taxable
• No restrictions on withdrawals, money can be taken out and put back in the following year.

Taxable investment account

• Interest income, foreign interest and foreign dividends are 100% taxable at your current tax rate (lowest 20%, highest is 53%) Plus there is 15% foreign tax withheld. If personal your tax rate 30%, foreign dividends of $100 minus  $30 personal tax – $15 of foreign tax = $65
• Canadian Dividends have an eligible tax credit that increases the after tax yield. In theory, a Canadian could earn $40,000 in dividends tax free if they had no other income.
• Capital gains has the lowest tax rate because only 50% of the gain is included in income, so only $50 of a $100 gain would be included. High income earners (53% tax bracket) would only pay 26.5%  in income tax.

I only received two suggestions and didn’t receive any input from any Canadian bloggers or readers.  So, I asked a financial planner who works at one of my local bank branches to weight in.

From the United States, Bear with the Bull offered the following:

I am not sure I am most qualified to be a financial adviser and I really do not know Canadian tax laws. I would think they might want a mix of income, bond, possibly cash, and growth stocks.  For my 401, I have about a 60/40 split of stocks and income/bond allocation. So if they are looking for more cash / income, maybe they would be more comfortable with something more 40/60 instead. 

They probably would look to a portion to be cash or bond fund that could be used to maximize yearly retirement contributions and or have readily available should they need it.  Since the Canadian real-estate market is seemingly doing well, how about investing in some Canadian REITs?  It would have a short term growth opportunity and dividends as well.  ETF’s also seem to be the latest investing vehicle and generally have lower fees than mutual funds.

• The 40% equities ($120,000) 50% Canada 40% U.S 10% Emerging markets
• The 60% fix income ($180,000) Perhaps a 1/3 split.  $60,000 Bonds, $60,000 Reits, $60,000 Cash

Realize that this response and $5.00 will get you a good cup of Starbucks so take it for what it is worth.

From Belgian, Amber Tree Leaves offered the following:

Here is a potential solution, as I am not sure to fully understand the Canadian system, I will skip that part.

General comment: As they have not yet accumulated a lot of assets, it might be tough to retire in the next 8-10 years. It is reasonable to expect a severe correction in that period. As it seems that they have little investing experience, it might be better to go for an approach that generates cash from dividend stocks. The assumption here is that it generates higher yields than ETFs. 

• allocation: 70 % stock and 20 % bonds and 10 % gold.
• The 70% equities 20% in Canadian dividend stocks, 50% world wide in dividend paying stocks

The gold is there as a hedge against the really bad times. It should be managed in a way that it needs to be sold and converted into stock/bonds when the price rises a lot. Timing this is hard, it is not the goal to get the absolute top.

Bank Financial Planner

First of all, I believe that money has different weights or “gravity” depending on how you acquire it.  Inheritance money seems to have the most weight as often people feel they “owe” a higher degree of care of duty to it and are less likely to deal with it the way they would a lottery win or an insurance settlement.

Obviously, the first thing I would need to do is get a better understanding of their situation and their time horizon and risk tolerances.  Let’s assume they are comfortable with a balanced approach. I would recommend 60% equity/40% fixed income.  ($180,000 in equity and $120,000 in fixed income.)

I would recommend they start by contributing fully to TFSAs, which would account for $102,000 between the two of them.  In the TFSA, I would use a ladder of market linked GICs to give them diversification, security of capital and the potential for higher returns than offered by traditional GICs.  This allows them their only chance to earn interest without paying tax on every penny of it.  It also means there are no fees to pay on almost one third of their investments. 

For the non-registered account, I would recommend a core holding of a growth ETF portfolio ($100,000 with additional positions in our Canadian ($30,000), US ($15,000 and International ETF funds $25,000), with a portion in our US Dollar ETF $15,000) for additional diversification on currency. 

After the initial investment occurred, I would want to have an annual strategy to move the maximum TFSA contribution for each of the clients.  This would involve selling a position of the non-registered investments (unless there are additional savings available) and reinvesting in the same fund inside the TFSA to maintain the balance in the overall account.   This would allow the gradual transition into the TFSA accounts, helping with taxes and probate fees down the road.  A portion of capital gains (or losses) would be triggered each year, smoothing the tax impact on the clients.

I am not sure if this inheritance is big enough to bail out this couple’s retirement plan. A key element is understanding after tax returns when investing.

 

 

 

What advice would you give for inheritance money?

 

Having been raised by two hard working immigrate parents, I was expected to help out with the household chores. Like most rebellious teenagers, I would have preferred going out with my friends. My complaints were answered with “someday this house will be yours.” I responded that I will be retired by then and won’t even need the money from your house. Funny thing is that I was right. Counting on an inheritance to fund your retirement can be very disastrous. (BTW, my mother still lives in the same house)

Thanks to bidding wars for real estate in Toronto and Vancouver, there are a fortunate few who will receive a sizable inheritance. Case in point, I recently got a call from a family friend of my wife’s whose deceased parents’ home sold for 50% over asking. Turns out that her inheritance was going to be much bigger than expect and she was hoping for some financial advice.

Her first question was “do I have to pay any tax on the inheritance”?  In Canada, the short answer is “no”, the estate of the deceased will pay all applicable taxes and what is left over is dispersed among the heirs.

My first question to her was rather delicate.  “How stable is your marriage”? A sizable inheritance, if not kept separate from family financial assets, could be included in a divorce settlement. (Using the inheritance to pay off the mortgage is a prime example)

What advice would you give to this couple in their mid-fifties who will be getting a windfall of $300,000?

Some personal information:

• Empty nesters, very stable marriage
• Own their own home, mortgage free, no other debts
• Husband works part-time, can’t find work in his field
• She has been working contract to contract for many years
• No company pensions
• Total savings of $55,000 in self-directed retirement accounts, combined unused contribution room of $80,000
• Zero dollars in tax free savings account, unused contribution room of $52,000 each

Additional information

1. Contributions to their retirement accounts will only generate a tax refund of 20%, tax free compounding but withdrawals are 100% taxable, required to start taking money out at age 72
2. Maximum contribution to TFSA is $5,500 each per year going forward. No time restrictions on withdrawals or amounts
3. The Canadian dividend tax credit has an extra 1.25% yield over interest income. (4% dividend equal to 5% of interest income)
4. Foreign dividends are 100% taxable plus have an extra 15% foreign tax

Their goal is to retire in 8 to 10 years.

Recommendations assuming the couple are willing to open different investment accounts.

How much money would you allocate to each account. (for example)

(a) $80,000 in tax differed retirement account, $104,000 in tax free accounts, $112,000 in trading account

(b) $104,000 in tax free account, 196,000 in trading account

(c) $300,000 in trading account

(d) put in an alternative mix

What asset allocation percentage would you recommend (equities / fix income, or gold…)?

What diversification mix would you suggest, short or long term bonds, index funds, ETFs, dividend stocks, growth stocks….

Would you be willing to pay 1% fee to an adviser for a selection of index funds and ETFs or an additional 1.5% to buy mutual funds? (Total yearly cost of $4,500 to $9,000)

Please email me your suggestions to ricodilello@rogers.com and I will comply all the recommendations in a follow up post.

 

 

Is Basic Income the answer to a new AI world?

I am so glad that I am a retired senior. I don’t have to worry about a robot taking my job. Since I have lots of time on my hands to think, I wonder what a new AI world would look like. For example; will my 2 year old granddaughter even need to get a driver’s licence? Will the Uber or cab that she orders even come with a driver?

Now I have always been a big fan of science fiction movies. There is a scene in the movie “Logan” where Wolverine has to dodge driver-less trucks to cross the highway to help some people. Installing AI in 16 wheeler trucks could replace the need for a lot of truckers.

Fast food restaurants have been the training ground for teenagers and young adults.  I used to tell my kids that they better get a good education or you will end up using the phrase “would you like fries with that” while working at MacDonald’s. However, even MacDonald’s are installing new self-serve kiosks. Now you can even order your Starbucks coffee using your phone. Where will young people get work experience?

Everywhere I look, jobs are slowing disappearing, the new AI technology seems to have very few limits.

“For example, Australian company Fastbrick Robotics has developed a robot, the Hadrian X, that can lay 1,000 standard bricks in one hour – a task that would take two human bricklayers the better part of a day or longer to complete.”

Japan has the highest percentage of people over the age of 60 and their population is shrinking. As a nation, there is a shortage of workers and they have embraced the use of robots in the work place. This trend could be coming to North America sooner than you think.

As a baby boomer, I worry about the future cost of health care. The world population is aging and health care costs are raising. I hope that science fiction turns into reality and my caregiver looks something like this.

   or this 

Why universal basic income may be necessary

A 2013 study by Oxford University’s Carl Frey and Michael Osborne estimates that 47 percent of U.S. jobs will potentially be replaced by robots and automated technology in the next 10 to 20 years. Those individuals working in transportation, logistics, office management and production are likely to be the first to lose their jobs to robots, according to the report.

For many, basic income sounds like a free ride or welfare. Economist believe that masses of people will not just sit at home but will make a contribution by continuing to work. The basic income would allow recipients to explore other options not available to them if they are struggling just to survive,  such as retraining or to find new job opportunities.

In theory, new opportunities would spring up to replace jobs done by machines. However, there are some practical problems, like where will government get the money if less people are working to pay for a basic income program? The North American education system would require a major overhaul to put more job training skills into the curriculum.

Some additional information to consider

The government of Ontario just announced a three year basic income pilot project to help low income earners in three cities. A single person can apply to receive $16,889 a year and couples will receive $24,027. Recipients who are employed will keep what they made from their jobs but their basic income would be reduced by half their earnings. For example, a single person earning $10,000 per year from a part-time job would receive $11,989 in basic income ($16,989 less 50 per cent of their earned income), for a total income of $21,989.

Is basic income just a pipe dream or a future reality?

 

 

 

 

 

Two questions from a blogger regarding mandatory retirement withdrawals by boomers

It has been awhile since I receive any questions from fellow bloggers that could be answered in a post. I thought that since I am a baby boomer, these questions might make an interesting post. This is what he wrote:

“I’ve seen more than one article regarding baby boomers starting to take mandatory retirement withdraws this year. This is the start of some significant money leaving tax deferred accounts for many years.”

1. Do you see this significantly affecting asset management companies?
2. Do you see this money going back into investments or going into daily living expenses and recreational “retirement” stuff?

 

Background and Research

Having worked as a financial advisor, the majority of my clients had little interest in saving for retirement. It was at the bottom of their priority list. It comes to no surprise that nearly half of U.S. families have no retirement account savings at all.

A 2015 Government Accountability Office study found that show that 29% of Americans 55 and older don’t have any retirement nest egg or even a traditional pension plan. Those who do have retirement funds don’t have enough money: 55 to 64-year-olds have an average of $104,000 and those 65 to 74 have $148,000 in savings

Aside from this lone anomaly, we see pretty well-defined growth in average IRA balances as age increases. Pre-retirees generally have well over $100,000 in their IRA, while Americans in the 65-69 age range have over $212,000.

Now these averages are not the most accurate gage because of the amount of wealth held by the super-rich, see the chart below.

 

 

The simple answer to question number 1 is boomer’s mandatory retirement withdrawals should have little effect on asset management companies. In fact, they could be a good long-term investment. One factor that has clause Generation X and millennials to delay purchasing a home was due to the housing crisis, perhaps they will save more for retirement after watching their parents delay or struggle in retirement.

Some additional research

Social Security benefits are much more modest than many people realize; the average Social Security retirement benefit in June 2016 was about $1,350 a month, or a bit over $16,000 a year.

For someone who worked all of his or her adult life at average earnings and retires at age 65 in 2016, Social Security benefits replace about 39 percent of past earnings. For 61 percent of elderly beneficiaries, Social Security provides the majority of their cash income. For 33 percent of them, it provides 90 percent or more of their income.

Social Security is a particularly important source of income for groups with low earnings and less opportunity to save and earn pensions, including African-Americans and Latinos. Social Security represents 90 percent or more of income for 41 percent of Asian Americans, 45 percent of African-Americans, and 52 percent of Latinos, compared with 32 percent of whites.

The answer to question number 2, the majority of retirement funds in North America will be used to cover living expenses.

In my humble opinion, a retirement crisis is coming because we are living longer and saving less. Social Security is funded by two trust funds, one for retiree benefits and one for disability benefits. The 2034 date is the exhaustion date for both funds when combined. But if considered separately, the old-age fund will be exhausted by 2035, after which it would be able to pay just 77% of benefits.

Two ways to get answers to your financial questions: send me an email (ricodilello@rogers.com) or post a comment on my Financial Question and Answer page.

 

Tips on rebalancing your retirement portfolio

Many investors are in for a rude awakening when they open their year-end retirement plan statements. The bond portion will probably show negative returns. It could even wipeout a good portion of their positive returns from owning equities.

Now, the most common method used in rebalancing your established asset allocation mix would be to reduce the holdings that are up in value (sell stocks) and buy assets that have fallen in price (buy bonds). This practice may have worked very well in the past but interest rates are going up forcing bond prices down.

The chart below compares the S&P 500 with the IShares 20 plus year Treasury bond ETF

“The decades-long bull market in U.S. Treasuries has finally drawn to a close following Donald Trump’s surprise presidential election victory, according to mutual-fund manager Bill Miller.”

“Miller isn’t the first to call time on the bond bull market. Economist Henry Kaufman, the original “Dr. Doom” who is credited with calling the last bond bear market in the 1970s, told the Financial Times this week that the current bull run is at an end.”

In the past, when the Federal Reserve decided it was time to unwind its easy monetary policies, it would raise the federal funds rate fairly quickly. The Fed believes a neutral stance on monetary policy is reached somewhere above the 4% level. The current Federal Reserve is moving slower than normal. Based on an average of three rate hikes per year, it will take the Fed a little over 4 years to normalize interest rates.

Tip # 1

Short-term, reduce or eliminate investing in target date mutual funds since they automatically rebalance from equities to bonds. Plus they increase your bond exposure the closer you are to retirement.

Tip # 2

During a period of rising interest rates, the prudent strategy is to reduce the duration of your bond portfolio. That could mean using a short-term bond ETF or a ladder of GICs both of which would allow you to benefit from an increase in rates.

Tip # 3

If you’re comfortable with a little credit risk, use short-term investment-grade corporate bonds to get a little more yield.

Tip # 4

Cash is by far the safest asset class. Move some of your equity allocation and some of your fixed income allocation to cash. I have my doubts that President Elect Trump can get congress to pass all his stimulus agenda and even economists are unsure if these policies will actual increase economic growth.

Corrections in the bond market are not as uncommon as you think. Most have been short in duration. See the chart below:

Keep in mind that in the past, rate hikes were implemented  at a much faster pace than what the current Fed has purposed. Losses in the bond market could continue for longer than expected.

Hidden fees can destroy your retirement dreams

When asked about contributing to a company’s pension plan, my standard answer was always put in enough to receive the company’s matching percentage. Never turn down free money, it’s like receiving a yearly bonus of 2% or 3% of your annual salary.

However be aware of fees that are hidden in the fine print. Make no mistake, these fees do matter. They may seem tiny, barely noticeable but they can eat away your future. A one percent reduction in fees can add an additional 10 years to your retirement income. If two people have the same 7 percent return over time but one pays 1 percent in fees while the other pays 2 percent, the latter will run out of money 10 years earlier.

For nearly 30 years, the pension plan industry wasn’t legally required to explain exactly how much it was charging investors. Sadly, a recent industry survey showed that 67 percent of Americans believe they pay no fees in their 401(k) plan. In a recent survey in Canada, 36% of Canadians claimed that they paid no fees and 11% were unsure.

In a muddy but legal arrangement, a high percentage of plan providers accept payments from the mutual funds they offer in your 401(k) plan. This is called revenue sharing or, more aptly, paying to play. Naturally, the list you have to choose from includes the funds that pay the provider the highest amounts, rarely the best performing and certainly not the lowest in cost.

Additionally, many providers restrict low-cost funds to plans that exceed a certain amount of assets, meaning that employees of smaller companies are forced to invest in funds with higher fees. Since the providers don’t make much of a profit on the lower-cost funds they do offer, they will usually charge a significant markup. For example; you could be paying a 1 percent annual fee for an S&P 500 Index fund when the actual cost is .05 percent. That translates into a 2,000 percent markup.

“Last year the Obama administration announced that hidden fees and backdoor payments were costing Americans $17 billion per year. And that’s not counting the excessive “out-in-the-open” fees that are draining our retirement accounts. The Department of Labor is also sounding the alarm. “The corrosive power of fine print and buried fees can eat away like a chronic illness at a person’s savings,” said Labor Secretary Thomas E. Perez.

A company pension plan is a wonderful savings vehicle when it’s efficient. The problem is that many of these plans are plagued with a variety of additional hidden layers of fees. These added layers have seemingly arbitrary labels, such as “asset-management charges” or “contract asset charges.” They often add up to 1 percent or more and are buried in the fine print of plan disclosures.

New regulations for advisors

Beginning in April 2017, a financial professional who makes investment recommendations to you about your 401(k) or IRA will be legally required to provide advice that is best for your situation, not the funds that provide the most compensation to the advisor. “The advisor will now be required to disclose their conflicts of interest.” This new fiduciary standard will only apply to retirement accounts, and advice provided about other types of taxable investment accounts will not be held to the same standard.

Employers need to wake up and take their role as pension plan sponsors more seriously. It’s in their power to dramatically impact the future quality of life for their employees.

My advice;  put in enough to receive the company’s matching percentage and read the fine print before making any additional contributions to your company’s pension plan.

Beware of Negative Growth in Corporate Profits

 

 

 

My previous blog posts have been leaning towards being more bearish regarding the stock market. The revised forecast for negative growth in corporate profits for the first quarter of 2015 makes me wonder if forecasters will reduce their expectations for the second quarter as well. I find the magnitude of the decline in expectations are somewhat alarming. Previous estimates for the first quarter were for a gain of 8.57 percent, with the second quarter projected at 7.33 percent and the full year at 9.78 percent.

Some Wall Street forecasters are putting a positive spin, by discounting the negative earnings from the oil & gas sector,  claiming that the rest of the S&P earnings will be positive. Energy profits are forecast to tumble 62.51 percent in Q1 and about the same in Q2, with the full-year sector drop pegged at 57.08 percent.

While others point to the strong U.S. dollar as a headwind to weak earnings for the next two quarters.

“Since the end of World War II in 1945, each of the 10 economic recessions has been accompanied by a decline in earnings growth. Only three times during that period did negative earnings not see a recession follow”, according to Sam Stovall, chief equity strategist at S&P Capital IQ.

“While not an official profit recession, as no contraction in EPS growth is currently projected, the full-year growth estimate is getting uncomfortably close to that threshold,” Stovall said in a note to clients this week.

“Capital IQ expects the first quarter to show a loss of 2.92 percent for the S&P 500. Expectations for the second quarter, IQ sees a loss of 1.84 percent”.

These conflicting views makes it difficult for me to put money to work in the stock market. I am old school, in the past, the transportation sector has been a good indicator of economic activity. The one year chart below of the transportation ETF (IYT) shows signs of weakness. It is currently trading below its 50 & 100 day moving average and is close to breaking below the 200 day.

 

I will be focusing on changes in revenue (top line growth) over earnings which can easily be skewed. I expect the railroads will show some weak revenue growth because they depend on transporting commodities like oil and coal. Norfolk Southern released an earnings warning on Monday, first quarter earnings per share are expected to be $1.00 per share. That is 15% below the same quarter in 2014 and is primarily due to lower expected revenues.

Take a good look at revenue growth from parcel delivery companies, air freight and trucking companies to confirm that economic activity is getting stronger. Here are a just few names that I am watching.

 

C.H. Robinson	CHRW	27-Apr
Ryder Systems	R	22-Apr
J.B. Hunt	JBHT	14-Apr
United Parcel Service	UPS	28-Apr
FedEx	FDX	11-Jun
Forward Air Frieght	FWRD	21-Apr

The first quarter GDP of 2014 came in at -2.1% but rebounded to 4.6% in the second quarter. Could we have a repeat performance this year? Consumer spending was positive for March after three negative months in a row. The low price of gasoline will add $800 to $1,200 extra dollars this year into consumer pockets. I expect that those dollars will be spent during the second half of 2015!

 As I was writing this post, J.B. Hunt released their earnings report:

J. B. Hunt Transport Services, Inc., (NASDAQ:JBHT) announced first quarter 2015 net earnings of $91.9 million, or diluted earnings per share of 78 cents vs. first quarter 2014 net earnings of $68.7 million, or 58 cents per diluted share.

Total operating revenue for the current quarter was $1.44 billion, compared with $1.41 billion for the first quarter 2014. Current quarter total operating revenue, excluding fuel surcharges, increased 10% vs. first quarter 2014. Intermodal (JBI) load growth was 6% over first quarter 2014 levels.

 

 

 

Tug of War in the Oil Market

 

The tug of war continues between the oil bulls and the bears. Volatility continues in the price of oil which was up 6% on Tuesday and was down more than 4% on Wednesday after the Energy Information Agency (EIA) reported an inventory build of 19.95 million barrels (14 year high). This far exceeded the Thomson Reuters estimate of 3.43 million barrels.

The takeover of BG Group by Royal Dutch Shell poses the question whether the oil market has hit a bottom? The oil bulls believe that the halving in the price of crude is similar to the early 2000s when many super-mergers took place. Back then, BP acquired rival Amoco and Arco, Exxon bought Mobil and Chevron merged with Texaco.

The BG acquisition will provide Shell with enhanced positions in competitive new oil and gas projects, in Australia LNG and Brazil deep water. The other interesting point about this deal is the nearly total absence of North American assets. Shell has multiple reasons for buying BG, but more access to North America, is clearly not among them.

What I find fascinating is that 78% of BG Group’s reserves are in natural gas. Another curious fact, Shell has estimated the cost of its proposed LNG export terminal in Kitimat to be up to $40 billion (Canadian). It owns 50% of LNG Canada through its subsidiary Shell Canada Energy.

Paying a 50% premium for BG raises three more questions:

1. Is the BG takeover based on the current low price of natural gas or oil?
2. Is it cheaper to buy existing LNG plants than to build new ones?
3. Is it cheaper to buy existing deep water wells than to drill new ones?

Wild cards in the oil market:

1. When will Iran’s 30 million barrels stored in oil tankers hit the world market?
2. When will oil storage in the U.S. reach capacity?
3. How much of China’s cruel oil imports are going into storage?
4. When will low oil prices force U.S. share production to actually decline?
5. When will the Saudis cut production?

The price of oil has been stuck in a trading range but the current tug of war is slanting towards the bull side. According to oil experts, being interview in the business media, the hot money is flowing into oil stocks. The year to date price chart of the U.S. oil ETF (XLE) has moved above its 50 and 100 day moving average.

I am not an expert when it comes to analysing chart patterns. I do know that the daily trading volumes are on the weak side. I have seen many money managers on business networks indicate that they dipping their toes into oil stocks. They are reluctant to call a bottom but they are buying some large integrated oil stocks and refineries.

The XLE has 28% of its value composed of Exxon and Chevron shares. Both of these companies report their earnings on April 30th along with Royal Dutch Shell. BP earnings come out two days earlier on April 28th and I have mention in a previous post that I own some bearish BP puts in my play money account. By the way,  the BP puts are currently under water but it is money that I can afford to lose.

Remember, trading in the oil market is being dominated by hedge funds with very deep pockets.