Sentiment Speaks: It's Time To Challenge What You Think You 'Know' About The Stock Market

Recent price action

The S&P500 dropped from the resistance region I had cited, and provided us with the minimum 30 point drop I was looking for (we dropped 34 points from the prior all-time high). As we caught the lows last week in real time, the market is trying to push up towards our next higher target in the 2611SPX region.

Anecdotal and other sentiment indications

I know I am not the traditional author you come across here on Seeking Alpha. Most others will provide you with traditional notions of the stock market based upon rationalities. So, many authors will suggest that we “cannot separate public policy and geopolitics from the markets,” they will focus on “market valuations,” they will claim that “fundamentals do not support this rally,” and will provide you with many, many other reasons as to why they have continually believed that this rally would never happen.

Yet, they have been left on the sidelines, scratching their heads for the last year and a half, as the US equity markets have rallied over 45% since February 2016.

I mean, think about all the reasons they have put before you over the last year and a half regarding the imminent risks facing the stock market, which they have lead you to believe will stop the market in its tracks. I have listed them before, and I think it is worthwhile listing them again:

Brexit – NOPE

Frexit – NOPE

Grexit – NOPE

Italian referendum – NOPE

Rise in interest rates – NOPE

Cessation of QE – NOPE

Terrorist attacks – NOPE

Crimea – NOPE

Trump – NOPE

Market not trading on fundamentals – NOPE

Low volatility – NOPE

Record high margin debt – NOPE

Hindenburg omens – NOPE

Syrian missile attack – NOPE

North Korea – NOPE

Record hurricane damage in Houston, Florida, and Puerto Rico – NOPE

Spanish referendum – NOPE

Las Vegas attack – NOPE

And, each month, the list continues to grow.

Yet, the same authors you have read for years just continue to repeat their mantras that we “cannot separate public policy and geopolitics from the markets,” they continue to focus on “market valuations,” and they continue to claim that “fundamentals do not support this rally.”

Einstein was purported to suggest that insanity is doing the same thing over and over while expecting a different result. But, you see, in the stock market, there is a bit of a difference. Just as trees do not grow to the sky, the stock market will not rally indefinitely. So, we will eventually see a bear market. Then, the broken clock syndrome will prove these authors to be “right,” rather than simply insane, and we will hear it from them incessantly about how they tried to warn us. Yes, warn us indeed.

Now, that does not mean we should expect analysts to be right all the time. Clearly, I was expecting the set ups we have seen in the metals market to spark a big rally in 2017, but when we broke upper support back in September, it caused me to turn quite cautious until 2018. But, the difference is that I use an objective methodology that listens to what the market is saying rather than trying to force a predetermined linear perspective on the market.

And, that is the issue with most of the bearish presentations you have read for the last year and half about the stock market, while they claim they are simply “opening your eyes to the inherent risks in the stock market.” Let me ask you a question: Is there anyone reading this article that believes the stock market does not have risk at all times? I will not belabor this point, but, needless to say, these bearish presentations couched as “risk awareness” is not based upon objective perspectives on the stock market.

My friends, look at the events I have listed above yet again. None of them (nor ALL of them cumulatively) have been able to put a dent in this market advance over the last year and a half. So, rather than view the market from a perspective of insanity, maybe one should come to the conclusion that public policy, geopolitics, market valuations, or fundamentals are really not what drive the stock market. Clearly, we have seen that none of this has mattered one iota. So, maybe we need to consider that there is a stronger force at work which overrides any of the traditional perspectives you were lead to believe drives the market?

Bernard Baruch, an exceptionally successful American financier and stock market speculator who lived from 1870– 1965, identified the following long ago:

All economic movements, by their very nature, are motivated by crowd psychology. Without due recognition of crowd-thinking … our theories of economics leave much to be desired. … It has always seemed to me that the periodic madness which afflicts mankind must reflect some deeply rooted trait in human nature — a trait akin to the force that motivates the migration of birds or the rush of lemmings to the sea … It is a force wholly impalpable … yet, knowledge of it is necessary to right judgments on passing events.

Price pattern sentiment indications and upcoming expectations

The upcoming week is rather simple, and centered around the 2572SPX region. As long we hold over the 2572SPX early in the coming week, we are on our way to the 2611SPX region.

However, if we break down below 2572SPX early in the coming week, it opens the market up to another decline which will revisit the 2520-2550SPX support region before we finally rally to the 2611SPX region.

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Housekeeping Matters

For those looking for accurate insight into various markets, including VIX/VXX, FOREX, Dow Jones, etc., I also HIGHLY suggest you read Michael Golembesky’s work on Seeking Alpha.

Lastly, it seems that Seeking Alpha has changed the way they tag articles. So, while my articles used to be sent out as an email to those that follow the metals complex, they are now only being sent out to those that have chosen to “follow” me. So, if you would like notification as to when my articles are published, please hit the button at the top to “follow” me. Thank you.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Tech

GE Is A Horrible Dividend Stock So Choose These 2 Dividend Kings Instead

I’m a big fan of contrarian value investing, having recently taken stakes in two beaten down dividend stocks trading at 52-week lows.

So when I see a blue chip like General Electric (GE) trading at not just a 52-week low but also one of its highest yields in almost a decade, it certainly piques my interest.

BUT there is a big difference between being a contrarian and foolishly investing in something with horrible dividend growth prospects.

So let’s take a look at three reasons why I’m avoiding GE like the plague, and instead have 3M (MMM), and Illinois Tool Works (ITW) on my EDDGE 3.0 portfolio buy list.

GE’s Flailing Turnaround Drama Continues

After a failed 16-year tenure at GE, Jeffrey Immelt has left the company, to be replaced by John Flannery, who promises to finally unlock the company’s strong growth potential.

The problem is that while Flannery, a 30-year veteran of the company and former head of GE Healthcare, has a solid track record as a turnaround artist, the strategy he’s outlined is no different than Immelt’s.

Specifically, Immelt wanted to return to GE’s industrial roots by selling off the vast majority of GE Capital (the company’s most profitable and FCF rich segment) and focus on core industrial brands.

Now back in 2009, this made a lot of sense. After all, GE Capital’s implosion during the financial crisis is what nearly bankrupted the company and forced it to slash its dividend by 68% back then.

And with strict new banking regulations, GE didn’t want the headache of holding onto the financial businesses that aren’t directly tied to financing customer acquisitions of its industrial products.

However, where Immelt went so badly wrong is to use the one-time windfall from the sale of GE Capital to buy back copious of stock rather than reinvest into expanding the company’s industrial portfolio.

Chart GE Revenue (TTM) data by YCharts

And since GE sold off not only its financial arm, but numerous other “non-core” businesses as well, the result has been a steady decline in sales, earnings, and especially free cash flow, which is what ultimately funds and grows the dividend.

Source: GE Investor Presentation

Now Flannery says he’s going to double down on Immelt’s failed strategy by selling off even more businesses, such as selling off its water division for $ 3.4 billion.

Now some GE bulls will argue that this water sale was necessary in order to close the acquisition of Baker Hughes (BHGE).

However, let’s remember that GE made a bunch of its energy investments at the top of the oil cycle (overpaid) and the merging of Baker Hughes with GE’s oil business, and then spinning it off as a separate company isn’t going to be a major needle mover for the company.

In fact, GE paid Baker Hughes shareholders a $ 7.4 billion special dividend, and because it now owns just 62.5% of the new company, even if oil prices recover to $ 60, and management realizes its planned synergies, the bottom line benefit to GE shareholders will be $ 0.08 per share in 2020.

In other words, if everything goes right (including much higher oil prices that management has no control over), then the deal will increase GE’s EPS by 10% over a three-year period or 3.2% CAGR.

Which basically shows the problems facing GE, specifically that management is flailing and churning through assets while burning cash in an effort to “do something” to hopefully refire the growth engines.

In the meantime, the company’s short-term moves appear nothing more than desperate window dressing to appease Wall Street.

For example, the company recently announced it was selling its five corporate jets to save money. However, as analysts have pointed out the cost savings will be minimal ($ 333,000 last year), and using charter planes could end up actually increasing expenses in the long run.

The company is also ending its company car program for 700 executives, as part of a $ 2 billion cost cutting effort (by the end of 2018).

Now don’t get me wrong, I applaud any effort to cut costs, especially by this much and this fast.

However, let’s be realistic. In 2016, GE’s total compensation to its top five executives was $ 78.2 million, $ 8 million of which was through perks such as company cars and private jet travel.

Which means that the savings that Flannery is talking about can’t be obtained by such PR stunts.

What’s worse? Even if GE’s is able to cut costs by $ 2 billion by the end of next year, given that it’s generated NEGATIVE $ 2.5 billion in free cash flow in the past 12 months, it would still not be FCF positive; much less be able to cover its $ 8.6 billion dividend.

Or to put another way, GE needs to grow to save its dividend and its status as a dividend investment, something it’s not been able to accomplish over the past decade.

3M And Illinois Tool Works: Dividend Kings With Far Superior Fundamentals

Whereas GE’s track record in the past decade has been terrible, 3M and Illinois Tool Works have proven themselves some of their industry’s highest quality names.

Chart GE Revenue (TTM) data by YCharts

Now keep in mind that between 2012 and 2016, the world’s been in an industrial recession, thanks to the bursting of several commodity bubbles (due to China pulling way back in infrastructure spending).

Add to this the worst oil crash in over 50 years, and all industrial companies have struggled with top line growth.

However, the difference between GE and its far superior rivals is that they’ve managed to adapt their business models, through cost cutting and increased sales of their highest margin products, to generate impressive EPS and FCF/share growth.

Company Operating Margin Net Margin FCF Margin Return On Assets Return On Equity Return On Invested Capital
General Electric 12.6% 6.1% -2.1% 1.9% 9.2% 2.7%
3M 24.7% 17.7% 17.6% 16.0% 45.9% 19.6%
Illinois Tool Works 23.2% 15.5% 13.8% 13.9% 44.6% 17.4%
Industry Average 12.9% 8.6% NA 4.8% 15.9% 6.1%

Sources: Morningstar, CSImarketing

In fact, when we look at these companies’ profitability profiles, specifically margins and returns on capital, a great proxy for the quality and effectiveness of their respective management teams, we see that GE isn’t even in the same ball park.

For example, Illinois Tool Works’ response to the industry turnaround has been to consolidate over 800 regional units into just 85 global ones.

Source: Illinois Tool Works Investor Presentation

The company has also sold off lower margin, commoditized segments, such as decorative surfaces and industrial packaging, to focus on higher margin segments, which are growing faster than the global industry as a whole.

This is why ITW now expects organic growth to be be at least 2.5% above the industry norm going forward.

Add to this steady cost cutting of over 1% a year, and it’s not hard to see why Illinois Tool Works is now one of the industry’s best FCF generating machines, which allowed the company to hike its dividend by an incredible 20% in 2017.

Better yet? ITW’s experienced management team believes its current strategy will be able to continue generating double-digit dividend growth (and total returns) for the foreseeable future.

Meanwhile 3M’s turnaround strategy has similarly been a great success, especially compared to the horror show at GE.

3M: Industry’s Innovation Leader

Just like Illinois Tool Works, 3M has responded to the global industrial recession with disciplined and well executed changes, especially a focus on streamlining its operations, and targeted bolt and highly accretive bolt-on acquisitions.

Source: 3M Investor Presentation

However, the company hasn’t skimped on its bread and butter, well allocated R&D spending that is the key driver of its historic innovation success.

This spending (5.9% of revenue in last 12 months) is expected to boost its healthcare sales by 2% to 4% a year, while $ 500 million to $ 600 million in cost cutting should further grow EPS by about 1.5% a year.

In the meantime, about 50% of 3M’s sales are in fast consumable products, resulting in far stronger recurring cash flow than GE (or most peers). The company also benefits from strong exposure to emerging markets (47% of sales) which should increase to 50% by 2020.

That in turn will allow 3M to grow faster than most industrial stocks, including about 10% EPS and FCF/share growth, which in turn should drive some of the industry’s best payout growth in the coming decade.

The bottom line is that while GE is churning assets, and burning through shareholder cash, both Illinois Tool Works and 3M have successfully proven their ability to adapt to tough industry conditions and continue growing investor profits.

This bodes extremely well for their dividend focused investors, especially now that the industry is recovering.

Dividend Profiles Are No Contest

Company Yield TTM FCF Payout Ratio 10-Year Projected Dividend Growth 10-Year Potential Annual Total Return
General Electric 4.1% -34.0% 3% to 4% 7.1% to 8.1%
3M 2.2% 50.9% 8% to 11% 10.2% to 13.2%
Illinois Tool Works 2.1% 45.4% 10% to 12% 12.1% to 14.1%
S&P 500 1.9% 34.7% 6.1% 8.0%

Sources: Gurufocus, Morningstar, Fast Graphs, CSImarketing.com, Multpl.com

Ultimately as a long-term dividend growth investor, I’m concerned with three things: the yield, the safety of the dividend, and its long-term growth potential.

That’s because historically dividend growth stocks’ total returns follow the formula yield + dividend growth. And while true that GE’s yield is currently far superior to those of the market, and 3M and Illinois Tool Works, it’s also not sustainable.

After all, GE’s negative free cash flow means that it is having to pay the dividend out of cash on the balance sheet and or debt. And even once the company does return to FCF profitability, it will have to grow its cash flow at a torrid pace just to cover the payout, much less lower its payout ratio to a sustainable level of 40% to 60%.

On the other hand, both 3M and ITW have highly secure payouts, courtesy of conservative payout ratios and far stronger balance sheets.

Company Debt/EBITDA EBITDA/Interest Debt/Capital Current Ratio S&P Credit Rating
General Electric 3.69 3.84 48% 1.85 AA-
3M 1.92 42.88 48% 2.22 AA-
Illinois Tool Works 2.17 14.55 57% 2.32 A+
Industry Average 2.09 7.71 45% 0.83 NA

Sources: Morningstar, Fast Graphs, CSImarketing

And let’s not forget that as dividend kings, 3M and ITW have grown their dividends every year for 58 and 53 years, respectively.

Chart GE Dividend data by YCharts

This means that both companies have far more shareholder friendly (and conservative) corporate cultures, with proven track records of sustaining and growing their payouts during even the most turbulent of economic and industry conditions.

Chart GE data by YCharts

That in turn has resulted in far superior total returns over the past decade; a trend I expect to continue long into the future.

Valuation: GE Isn’t As Undervalued As You Think

Chart GE data by YCharts

In terms of performance in the last year, it’s no contest. 3M and ITW have benefited from the Trump bump in industrial stocks, while GE has been falling steadily.

Of course, from a valuation perspective that’s not a good thing.

Company Forward PE Historical PE Yield Historical Yield % Of Time Yield Has Been Higher (Last 22 Years)
General Electric 13.4 17.5 4.1% 3.2% 1%
3M 22.6 16.4 2.2% 2.4% 72%
Illinois Tool Works 21.2 15.8 2.1% 2.2% 34%
Industry Average 23.1 NA 1.3% NA NA

Source: Gurufocus, Yieldcharts

After all, it means that industrial stocks in general are trading at very high levels, with both 3M and ITW far higher than their historical PE ratios.

Meanwhile GE, at least from this short-term perspective, appears to be on sale.

This is especially true when we look at GE’s yield compared to its historical average. In fact, over the past 22 years, GE’s yield has only been higher about 1% of the time, while 3M’s has been greater 72% of the time, and ITW’s 34%.

However, when we take a longer-term, 20-year forward view, things look a bit different.

Company TTM EPS 10-Year Projected EPS Growth Fair Value Estimate Growth Baked Into Current Share Price Margin Of Safety
General Electric $ 0.80 5.5% (conservative case) $ 9.47 17.3% -61%
11.0% (bullish analyst consensus) $ 14.59 -147%
3M $ 8.77 10.0% $ 167.62 13.7% -29%
Illinois Tool Works $ 6.18 10.7% $ 119.91 14.0% -27%

Sources: Morningstar, Fast Graphs, Gurufocus

Normally, I like to use a discounted free cash flow analysis to determine an approximate fair value for stocks such as this. However, since GE is cash flow negative right now, we need to look at a discounted earnings model instead.

Using a 9.0% discount rate (the opportunity cost of money since a S&P 500 index ETF would have historically generated 9.0% CAGR since 1871), we find that indeed both 3M and Illinois Tool Works are substantially overvalued (meaning they are both “holds” right now).

However, GE is actually far more overvalued, even if you assume that the analyst consensus of 11% EPS growth over the next decade is correct. In reality, I think the company will generate far slower growth which means that its shares are far more overvalued than 3M and ITW’s.

And so while today may not be a good time to buy 3M or Illinois Tool Works, it’s an even worse time to add GE to your portfolio.

Risks To Consider

While I’m a huge fan of 3M and Illinois Tool Works, and eventually plan to own both, there are nonetheless some major risk factors to consider.

First, all industrial conglomerates are cyclical since their business is tied to the health of the global economy, and especially commodity sensitive industries such as mining and energy.

Currently accelerating economic growth and a recovery in commodity prices (especially oil) means that 3M and ITW’s bottom line growth prospects have the wind at their backs.

However, a global recession could quickly unravel this and throw up strong growth headwinds. And given the strong rally in the past year, both dividend kings could face a strong pullback in such a scenario (which will make for a potentially great buying opportunity).

Next we can’t forget that due to their international sales, both 3M and ITW also face significant currency risks. Specifically that a strong dollar (which is likely to result from rising US interest rates) could slow top and bottom line growth because their products would become more expensive overseas. In addition, local currency sales would be converted to fewer dollars for accounting and dividend payment purposes.

Chart ^DBLUSD data by YCharts

In the past year, the US dollar has actually declined significantly (helping boost both company’s profits), but given the natural volatility of currencies, and where the Fed is signaling that rates are going, investors can’t necessarily expect this trend to continue.

Bottom Line: GE Is A Wet Cigar Butt, While 3M And Illinois Tool Works Are Grade A Gems Worthy Of Your Watch List

Don’t get me wrong. GE is currently pricing in such low expectations that it’s possible that it might have a strong short-term bounce if only management can suck less than expected.

BUT as a long-term dividend growth investor, I’m not willing to speculate on such an eventuality, not when there are so many far superior investing alternatives right now.

And while 3M and Illinois Tool Works may not currently be attractively priced, I’m far more eager to place them on my watch list and wait for the next market correction to add these two dividend growth legends to my portfolio, than take a wild eyed gamble that GE can finally turn its ailing ship around.

And if you currently own 3M and Illinois Tool Works, then I recommend continuing to do so, as they both are epitomes of a “buy and hold forever”, sleep well at night (SWAN) dividend growth stocks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Tech

Report: BMW X3 diesel emissions exceed EU regulations, company stock falls

The reverberation of the Volkswagen tailpipe emissions scandal is still being felt across the industry, pulling other brands under the harsh light of scrutiny.

According to a report out from Germany’s Auto Bild, the Nitrous Oxide (NOx) tailpipe emissions of BMW’s X3 diesel compact crossover exceed European regulations. In fact, the car’s respiratory-harming NOx emissions exceeded future Euro 6 emissions levels — set to go into effect in 2017 — by as much as 11 times.

The report is based upon tests performed in October, 2014, by the International Council on Clean Transport (ICCT), the independent nonprofit focused on clean energy that originally discovered VW’s emissions cheating. Read more…

More about Cars, Tech, Transportation, Diesel, and Bmw


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