Adrian Wong's Blog - Adrian's Investment Models

Website Updates - 2/25/2015

2/25/2015

I added a "Direct Access To Investment Models" page for those who want to download an Excel workbook with my investment models. There is a modest $1/month subscription fee. This took me a few days to plan, add a subscription membership system to the site, and to design/protect the Excel workbook.

I've been doing some research on the number of rigs versus oil production. I plan to present the data this weekend with my weekly energy industry update. I'm also thinking of building a model to estimate future stock market performance since that is a major industry investment model input.

You might be wondering how much web traffic I'm getting on this site and Seeking Alpha.

Website: 505 unique visitors, 1756 page views since website launch (1/17/2015)
Seeking Alpha: 12 followers gained, 7 blog entries shared, 7895 web and mobile page views

Below is my outstanding to-do-list:

Why the price estimate of my Energy Industry Investment Model is much lower than the Energy Select Sector SPDR ETF's (XLE) price. I'm looking for evidence to support my hypothesis that dividend investors are propping up energy industry stocks.
The reason why merchant wholesaler inventory levels affects consumer staples industry stocks. I suspect two reasons: higher merchant wholesaler inventory levels equate to higher profit margins for consumer staples retailers or inventory levels is a result of future sales expectations.
Look into building a stock market performance model.

Consumer Staples Industry Weekly Update: Surfing With The Market

2/21/2015

*Disclosure: I don't hold or plan to trade any of the securities mentioned in this blog within the next 48 hours.

This week I will show you the latest retail data in the chart below on three retail segments of the consumer staples industry versus the rest of the U.S. Census Bureau's Retail Trade and Food Services Sales segments on the secondary axis.

In terms of consumer staples retail sales, health and personal care stores have the slowest growth while warehouse clubs and superstores grew rapidly from 1992 through 2008. In all cases the consumer staples retail sales aren't as volatile and significantly impacted by recessions as the rest of the retail trade and food services segments. Consumers will always purchase essential retail goods. Although the sales consistency of consumer staples companies are relatively boring investors will feel more secure owning them during recessions.

Select Consumer Staples Retail Sales Figures

Source: U.S. Census Bureau

The below chart shows the latest estimate of the Consumer Staples Select Sector SPDR ETF (XLP), my proxy for the consumer staples industry. With the stock market reaching new highs this week, my model increases the estimated price of XLP a few cents from $51.24 last week to $51.48 this week. The National Retail Federation's 4.1% retail sales growth 2015 projection provides a little bit of growth as the model predicts XLP's price will reach $52.83 by year end.

I saw three interesting articles today regarding the consumer staples industry that may impact XLP's performance.

U.S. west coast seaports are finally open as labor issues between dockworkers and their employers are resolved. This negatively affects both retail and inventory data from November to February and will probably boost March's data.
Proctor & Gamble (PG), the largest holding in the Consumer Staples Select Sector SPDR ETF (XLP) announced they are divesting 100 brands. This will definitely impact PG's sales in the near term but the magnitude of impact on XLP will depend on whether other companies in the ETF will absorb the brands.
The FTC is blocking Sysco's (SYY) acquisition of US Foods. Had the deal gone through we would expect Sysco's weight in XLP to increase.

Consumer Staples Industry Investment Model Estimated Price vs Consumer Staples Select Sector SPDR ETF (XLP) Close Price

The Consumer Staples Industry Investment Model uses merchant wholesaler data and stock market performance to estimate XLP's price. Merchant wholesaler data is highly correlated with retail sales data, but wholesaler data provides a better fit with XLP's performance.

This is it for this week's review of the consumer staples industry. For more information on the model please visit my website's Consumer Staples Industry Investment Model's page.

Weekly Update For The Energy Industry: More Record High Data

2/21/2015

*Disclosure: I don't hold or plan to trade any of the securities mentioned in this blog within the next 48 hours.

This week, crude oil production and stock levels continue to reach higher while crude oil prices retreat slightly. Two pieces of news this week that will impact petroleum product production going forward are the refinery worker strikes and Exxon Mobil's (XOM) refinery explosion.

The below two charts show weekly data for crude oil U.S. production, stocks, and imports. Despite the big drop in oil prices of the last few months, U.S. production is still at record highs leading to record high stocks levels. The second chart shows that as U.S. crude production increases the need for imports declines.

Weekly Data: Crude Oil Production vs Crude Oil Stocks

Source: EIA

Weekly Data: Crude Oil Production vs Crude Oil Imports

Source: EIA

The Energy Select Sector SPDR ETF (XLE) is my proxy for the energy industry. After updating my Energy Industry Investment Model with the latest oil production figures, oil prices, and stock market performance the results below show that XLE's 2/20/2015 closing price is still above my model's estimated price of $71.23. The large gap between my model estimate and XLE's price is because the ETF only dropped a little more than 20% since last summer while oil prices dropped by almost 50%.

EIA predicts that in 2016 oil prices will move up to $71/barrel and U.S. production will increase from this week's almost 9.3 million barrels a day to 9.5 million barrels a day. Using the EIA's estimates as inputs, I project XLE's price will be $84.68 in 2016.

Energy Industry Investment Model Estimated Price vs Energy Select Sector SPDR ETF (XLE) Close Price

I recommend investors stay away from XLE as the price is too high given the massive drop in oil price and continued record U.S. oil production and oil stock levels. Even though the EIA's estimates indicate that XLE will be worth $84.68 in 2016, it is notoriously hard to forecast oil prices. Last June as oil began its slide the EIA predicted $90/barrel oil prices in 2015. Also, few analyst expected OPEC's decision in November to not cut oil production. Finally, Investors should conduct extra due diligence when considering investments in individual energy companies.

The effects of the refinery strike and explosion is negative for three members of XLE's portfolio: Marathon Petroleum Corporation (MPC), Tesoro Corporation (TSO), and Exxon Mobil (XOM) but other members of XLE are likely to gain from this situation. Therefore, I didn't adjust model results because it would be hard to predict how these two events might impact the valuation of XLE as a whole.

Feel free to check out my website for more information about my Energy Industry Investment Model and stay tuned for next week's release of model results versus XLE.

Website Updates - 2/19/2015

2/19/2015

I love working on my blog, website, and investment models though it's hard to find time while working a full time job. That's why I haven't produced a blog/article for a few days. Here is my plan for the weekend and next week..

Release two blogs this weekend:

Weekly Energy Industry Investment Model Results and Analysis
Weekly Consumer Staples Industry Investment Model Results and Analysis

Continue researching the following items this weekend and next week:

Why the price estimate of my Energy Industry Investment Model is much lower than the Energy Select Sector SPDR ETF's (XLE) price. I'm looking for evidence to support my hypothesis that dividend investors are propping up energy industry stocks.
The reason why merchant wholesaler inventory levels affects consumer staples industry stocks. I suspect two reasons: higher merchant wholesaler inventory levels equate to higher profit margins for consumer staples retailers or inventory levels is a result of future sales expectations.

Thank you for coming to my website and thank you Seeking Alpha for posting my blog entries on your website.

Is The Consumer Staples Industry Fully Valued?

2/16/2015

*Disclosure: I don't hold or plan to trade any of the securities mentioned in this blog within the next 48 hours.

To answer this question my Consumer Staples Industry Investment Model looks at three important data sources: merchant wholesaler sales, merchant wholesaler inventory, and general stock market performance. I compare the model's estimated prices to the Consumer Staples Select Sector SPDR ETF's (XLP) closing prices.

Let's take a quick look at the three data sources in more detail:

Merchant Wholesaler Sales
Industry revenues is major determinant of industry value and performance. I used the U.S. Census Bureau's merchant wholesaler sales data instead of retail sales data. I found that retail sales is a better fit for the consumer discretionary industry.

Merchant Wholesaler Inventory
Changes in inventory levels are an important economic indicator. Another issue with the U.S. Census Bureau's retail sales data is that inventory data is provided only for the aggregate level but not for the sub category level.

General Stock Market Performance
Investor sentiment and economic performance and expectations influence general stock market performance which in turn influence publicly traded consumer staples companies.

Accuracy of the Consumer Staples Industry Investment Model

The below chart shows the higher correlation of the Consumer Staples Industry Investment Model versus XLP. This model also passed a backtest I conducted earlier this month.

Prices: Consumer Staples Industry Investment Model vs Consumer Staples Select Sector SPDR ETF (XLP)

Sources: U.S. Census Bureau, Yahoo Finance

What Is The Consumer Staples Industry worth?

Please see the below chart for the current and 2015 price estimates. I expect the XLP's price to remain roughly the same next year. The consumer staples industry as represented by the SPDR ETF XLP is fully valued.

Consumer Staples Industry Investment Model vs Consumer Staples Select Sector SPDR ETF (XLP)

Discussion

The National Retail Federation (NRF) announced that 2015 retail sales excluding automobiles, restaurants, and gas stations will rise 4.1%. Despite using the NRF's 2015 estimate for next year, it isn't enough to drive price growth much. Consumer staples relative to other industries is considered mature and slow growing; future growth is likely priced in.

Should I sell?

The Consumer Staples Industry as represented by XLP is fully priced unless you are looking for large share price increases. Investors holding consumer staples companies will continue receiving annual cash dividends of about 2 - 3% of share prices. Consumer staples companies are less risky than the overall stock market and should provide a degree of downside protection.

Prices can improve further if the stock market continues reaching or exceeding new market highs and/or merchant wholesaler inventory levels surge.

Why does surging wholesaler inventory levels help consumer staples companies?

This is a mystery I will explore in a future blog. I have two theories:

A rapid increase in the merchant wholesaler inventory indicates excess supply which may reduce COGS for consumer staples retailer gross margins.
Growing inventories implies higher expectations for future sales growth.

EIA's February Short-Term Energy Outlook Is Meaningless

2/16/2015

*Disclosure: I don't hold or plan to trade any of the securities mentioned in this blog within the next 48 hours.

EIA's Short-Term Energy Outlook

Source: EIA's Short-Term Energy Outlook

EIA's Short-Term Energy Outlook released this week. You can see from the chart above that crude oil prices and production barely budged from last month making this updated EIA report meaningless for changes in some of the Energy Industry Investment Model's inputs. I was expecting the recent rise in crude oil prices and continued supply increases to change EIA's 2015 and 2016 outlook.

Energy Industry Investment Model vs Energy Selelct Sector SPDR ETF (XLE)

Two things materially affected model results this week: crude oil prices moving into the high $50/barrel range and record high stock market prices. The Energy Industry Investment Model increased the current price estimate from $66.97 last week to $72.36 this week versus the Energy Select Sector SPDR ETF's (XLE) move from $79.82 to $82.04. Please visit the Energy Industry Investment Model's page for the latest commentary, model description, and backtesting results.

How Correlated Are Crude Oil Prices To Finished Petroleum Products?

2/15/2015

*Disclosure: I don't hold or plan to trade any of the securities mentioned in this blog within the next 48 hours.

Refineries turn crude oil into finished petroleum products like motor gasoline, diesel fuel, and jet fuel. Today we are going to look at how closely four petroleum products track crude oil prices. The chart below shows that truth. Over a long period the four major petroleum products track very closely with crude oil prices. I indexed prices to June 2006 at 100.

Price Index Crude vs Petroleum Products

Source: EIA; Note: Prices are Index at 100 based on June 2006 prices

Price correlations shown below are close to 100%. The most important petroleum product investors should be paying attention to is motor gasoline which accounts for 50% of all petroleum products production. The next largest category is EIA's distillate fuel oil which is 24% of production. This group includes many variants of diesel fuel and heating oil. I used the No. 2 Diesel Fuel and No. 2 Heating Oil prices to represent the distillate fuel oil group.

Correlation and Production of Crude Oil and Petroleum Products

Source: EIA

Digging deeper into current history (chart below) we see that motor gasoline prices follow the drop in crude oil prices in magnitude. Historical correlations don't tell everything. What is unique is the slower price declines of the other petroleum products relative to crude oil. This may help refineries see a smaller profit dip as their input costs (crude oil) drop more than their output revenues (petroleum products). This affects integrated oil companies in the Energy Select Sector SPDR ETF (XLE) such as Exxon Mobil (XOM) and Chevron (CVX). Perhaps they may beat earnings expectations next quarter.

Price Index Crude Oil vs Petroleum Products

Source: EIA

Knowing that not all petroleum products have the same price elasticity to changes in crude oil could make a difference in smaller energy companies which may be more focused on refining and selling specific types of petroleum products. As investors we need to remain vigilant in our investments research. While it seems like common sense that prices of crude oil and petroleum products would move together, but when the environment suddenly changes our first assumption is that they will move proportionately but in this crude oil price collapse they don't.

Website Updates - 2/14/2015

2/14/2015

Happy Valentine's Day! Boston is bracing for another blizzard tonight and tomorrow. As long as my house doesn't lose power I can continue producing quality content for you, my growing group of readers.

My plan for the weekend:

Post weekly update for the Energy Industry Investment Model integrating the latest EIA's Short-Term Energy Outlook. (today if possible)
Post first weekly update for the Consumer Staples Industry Investment Model. (today or tomorrow)
If time permits, either research enhancements to the Energy Industry Investment Model and/or work on the Consumer Discretionary Industry Investment Model, (tomorrow or Monday)

Thanks for reading.

Surviving Recessions With Consumer Staples Companies?

2/12/2015

*Disclosure: I don't hold or plan to trade any of the securities mentioned in this blog within the next 48 hours.

Recessions are scary events for stock investors. There are many ways investors can blunt a recession's impact on a portfolio such as hedging with short stocks, buying puts, holding cash, buying treasuries. Today I'm going to look at how effective it would be to invest in consumer staples companies during trying times. I'm using the Consumer Staples Select Sector SPDR ETF (XLP) as my proxy for the consumer staples industry. This ETF tracks an index of companies that provide consumer essential products such as food, beverages, tobacco, personal hygiene products, and medicinal products. The ETF is heavily weighted towards the industry's largest companies such as Wal-Mart, Coca-Cola, Proctor & Gamble. You can find additional details on the ETF's official page.

The chart below plots prices of XLP versus the S&P500 Stock Index. It shows three distinct periods.

1999 - 2002: XLP moved in the opposite direction during the boom but together during the crash.
2003 - 2009: XLP trailed the index during the boom but dropped less during the crash.
2009 - 2014: XLP moved with the index.

XLP vs S&P500

Source: Yahoo Finance

Based on the data, XLP performs poorly or trails during boom periods but provides price stability during downturns. You may wonder why both XLP and the S&P500 Index move together after 2009. My theory is that investors scarred by the Great Recession would likely invest in safer companies such as consumer staples companies that are typically household names, profitable, and dividend paying. This investor focus and need for financial security would increase the price and influence of these safer companies in the S&P500 Index. As a result both XLP and the S&P500 Index will move together. For instance during the dot com era internet, techology, and software companies dominated dragging the S&P500 Index for the same ride to record price levels.

During recessions consumer sentiment falls significantly and low levels of consumer sentiment is a boom for consumer staples companies. I illustrate this in the chart below with XLP versus the University of Michigan's Index of Consumer Sentiment. Another interesting point is that the Index of Consumer Sentiment is more volatile than XLP's prices. I'm not sure if there is a connection.

XLP vs University of Michigan's Index of Consumer Sentiment

Sources: University of Michigan, Yahoo Finance

Investors interested in maintaining exposure in the stock market during economic downturns can consider investing in the consumer staples industry due to their lower volatility compared with the general stock market as represented by the S&P500 Index as their relative hedge against falling consumer sentiment. However, investors hoping to avoid the impact of recessions altogether will need to look for counter cyclical investments such as S&P500 puts.

This weekend I will officially introduce my Consumer Staples Industry Investment Model to the world. The model will provide estimates of the Consumer Staples Select Sector SPDR ETF's (XLP) prices giving investors an idea of whether the ETF is under or overvalued. Model results will be posted weekly on my website. Below is a taste of its accuracy. Backtesting results are available in a previous blog entry on my website's journal section.

XLP vs Consumer Staples INdustry Investment Model

Sources: U.S. Census Bureau, Yahoo Finance

Energy Industry Investment Model - Backtesting Results Revisited

2/10/2015

*Disclosure: I don't hold or plan to trade any of the securities mentioned in this blog within the next 48 hours.

On 1/17/2015 I completed my backtest of the Energy Industry Investment Model. However, I'm going back to revisit the backtesting process and results in light of what I learned conducting the Consumer Staples Industry Investment Model backtest.

Fixed a statistical mistake

I narrowed the price gap between the Fidelity Select Energy Portfolio (FSENX) compared with the Energy Industry Investment Model with correlation remaining at 91.3%. Previously I didn't adjust the model based on the starting position of the data set correctly. This adjustment shifts the entire model results up linearly but doesn't affect the underlying model mechanics. The result is improved price accuracy as evidence. See charts below.

Energy Industry Investment Model Backtesting Results

Sources: EIA, Yahoo Finance, World Bank

Energy Industry Investment Model Backtesting Model Misses

Sources: EIA, Yahoo Finance, World Bank

91.3% Backtesting results are good but not good enough for me

I want to aim for a 95% correlation backtesting result. The model results have a very strong 97% correlation with the Energy Select Sector SPDR ETF (XLE) from 1998 to 2014. Modeled prices move in a similar fashion but are consistently below FSENX prices during the 1980s and consistently above FSENX prices during the dot com era (1998 - 2000). Future model enhancements will likely increase model backtesting results. I'm going to concentrate my efforts reviewing data in the following areas:

Crude Oil Consumption, Stocks
Petroleum Products Statistics: Gasoline, Fuel Oil, Jet Fuel
Natural Gas Statistics
Refinery Statistics

Adrian Wong

I'm just a guy who is passionate about investments. Go to "About Adrian" for more information about me

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