Dissecting the Dow: U.S. Companies Sitting On Cash Rich Balance Sheets

Dissecting the Dow
U.S. Companies Sitting On Cash Rich Balance Sheets

Alfred Lee, CFA, DMS
Investment Strategist, BMO ETFs
Global Structured Investments
alfred.lee [at] bmo.com

January 20, 2011

Recent Developments:

• As we mention in our upcoming BMO ETF 2011 Outlook Report, we believe U.S. equities could be well positioned this year, given that a good number of non-financial companies are showing cash-rich balance sheets.
• U.S. equities have experienced a strong rally since U.S. Federal Reserve (Fed) Chairman, Ben Bernanke signalled he would consider more quantitative easing (QE2) in late August. A closer look at the breadth of the rally in the Dow Jones Industrial Average (DJIA) using a hi-low index shows a majority of the stocks participating in the rally, as opposed to the increase in the DJIA being driven by only a few strong stocks. This suggests a healthy rally and not one driven by divergence. (Chart A).
• To-date since September 28, 2010, the implied volatility of emerging market equities has risen, whereas the implied volatility of DJIA has fallen in the same time frame. Although the implied volatility level of both markets are at relative lows compared to each of their respective 12-month highs, a higher implied volatility suggests increased market nervousness relative to lower implied volatility. (Chart B).
• The Fed’s effort to stimulate the economy has led to a reflation of asset prices, benefiting both commodities and stock prices. (Chart C)

Opportunity:

• The Dow Jones Industrial Average (DJIA) is made up of 30 large cap U.S. blue-chip companies. Many of these corporations are multi-nationals, which generate a sizable amount of top-line revenue through emerging market nations. Although some notable emerging markets are focused on tightening monetary policy, its middle class continues to grow, placing growing demand on products from companies such as 3M Company, McDonald’s Corp. and Procter & Gamble Company. Additionally, the DJIA trades at a price-to-earnings ratio of 14.1x compared to the 16.1x of the broader S&P 500 Composite Index. This may be a consideration for investors looking for better valuations.
• As foreign investing involves currency movements, currency hedged products are an option for those investors that desire pure exposure into the underlying asset class. Exchange-traded funds (ETFs) are an efficient way to obtain this pure exposure to an underlying asset class and eliminate much of the volatility due to currency.
• The BMO Dow Jones Industrial Average Hedged to CAD Index ETF (ZDJ) is an efficient way for investors to gain access to the Dow Jones Industrial Average Index (DJIA) while mitigating currency risk. For more information on the ZDJ, please read more.

Chart A: Hi-Lo Index Shows Breadth in DJIA Rally Since September

Source: Bloomberg, BMO Asset Management Inc.

Chart B: Implied Volatility of DJIA on the Decline Relative to Emerging Market Equity

Source: Bloomberg, BMO Asset Management Inc.

Chart C: Equities And Commodities Benefit From the Fed’s Reflation Efforts

Source: Bloomberg, BMO Asset Management Inc.

*All prices as of market close January 17, 2011 unless otherwise indicated.

Disclaimer:
Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.

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