Opinions and observations expressed on this blog reflect the authors' individual experiences and should not be construed to be financial advice. None of the members of this blog are licensed financial advisors. Please consult your own licensed financial advisor if you wish to act on any recommendations here.

Thursday, October 28, 2010

Double-Dip Recession Seems Unlikely

This article sums it up reasonably well: http://money.cnn.com/2010/10/28/news/economy/no_double_dip/

We are clearly in a time of slow growth, which was admittedly surprising given how the data were coming in around mid-April. As the Arouba-Diebold-Scotti Business Conditions Index shows, we seemed to hit an air pocket in the late spring and the loss of the temporary Census jobs has made things look even worse since then:

However, this does seem to be abating with regional manufacturing surveys turning up from a three month or so downturn. Additionally, jobless claims may be easing downward slightly again. For a brief time it appeared as though we would be heading back in the 500,000 range again, which would present serious problems. Additionally, despite rapid deleveraging by households, consumer spending has remained steady as balance sheets are being repaired. Auto sales in October appear to be OK by recent standards (and recent standards only) and weekly retail sales have been hanging in there. Nothing stellar to be sure, but hardly the stuff of nightmares.

Housing, of course, remains a potential problem as house prices are declining again and appear likely to retrench for some time. It is possible that a renewed decline in house prices may cause a shock to consumer spending as consumers desperately attempt to rebuild their balance sheets by radically curtailing spending. This is the problem of deflation as consumers become frightened of their collapsing net worth and retrench. If the renewed decline in housing prices is more rapid than expected, this is a potential risk.

Now, the one thing to be truly concerned about is looming cuts in public sector spending, particularly potentially drastic cuts from the federal government. We all know the story about state and local governments (I work in state government so I've seen it first hand) and their pain has already been felt both on the street and in the data. However, with the likely changes in Congress it is quite likely that extensions of unemployment benefits, Medicaid enhancements, and many other programs will be severely cut back, directly harming personal incomes and reducing employment. In a time of depressed demand, it is terribly difficult to see how this is stimulative. Without being political here, the only economic case for a fiscal contraction being stimulative is where there is an ongoing fiscal crisis that is causing elevated interest rates and therefore a general credit crisis. There it is possible to see how deep cutbacks in government spending can be stimulative. In our case, it is hard to see.

Monday, October 25, 2010

El-Erian Says Quantitative Easing Will Cause Inflation


I say "Good". Inflation is necessary to unwind some of the excesses of the credit bubble over the past decade. Debt is denominated in nominal dollars and can be eroded via inflation. Particularly, inflation would help unwind the negative equity situation that many homeowners find themselves in.

Now, of course the flip-side is that this means higher interest rates and the plethora of issues that come with that. However, I think we have proven since mid-2008 that low inflation and low interest rates are not enough particularly in an environment of high consumer debt loads. The issue is if we get the sort of inflation we had in mid-2008 when commodity prices surged and had the effect of rapidly reducing real incomes. That makes servicing debt actually more difficult. To be honest, given the behavior of commodities markets so far, I am concerned about this prospect. It does seem that the excess liquidity likes to slosh in there at the moment (See the commodity charts below).

Thursday, October 21, 2010

Mutual Fund Fees

One of the most mundane, but most important, issues when choosing a mutual fund is the issue of fees. I know very few people who can tell me what their mutual fund fees are, but they should take a good long look at them. The same holds true with ETFs, which also charge management fees.

First, let's talk about why you should care. This is because fee differentials can do murder on your long term wealth. Let's take a large cap value fund at random, say the Janus Perkins Large Cap Value Fund. It has an expense ratio, the percentage of the fund's assets it collects as fees, of 1.12%. Compare that to the Vanguard Value Index Fund, which has an expense ratio of 0.26%. The Janus fund slightly outperformed the Russell 1000 Value Index since December 2008 (13.87% vs 13.65%) and actually underperformed the Vanguard Value Index Fund over th past year by over 300 basis points. This highlights the issue that most actively managed funds cannot (I should say "will not") beat index funds. However, even if it did maintain that 0.22% outperformance over a long period, that fee differential would wreak havoc.

Let's use a ten year example where the value index does 8.00% and the Janus fund does 8.22%. At the beginning of the period you invest $10,000 and the expense ratios are assessed at the end of each year. In the case of the Janus fund you end up with $19,487 and with the Vanguard fund you end up with $21,034, a difference of over $1,500 or nearly 8%. That's even with the Janus fund's small margin of outperformance before fees. Add in the issue that actively managed funds generate more problems with pass-through capital gains and the problem compounds.

None of this is to say that there aren't good actively managed funds that can, reasonably consistently, beat the S&P 500 or any other index that they may track over time. They might not beat it every year, but over the course of several years they do. Of course, do they beat it after fees and pass-through capital gains? That's possibly another story altogether.

What this all gets at is look at the fee schedule you are paying. If the expense ratio is much over 0.70%, you are probably paying way too much unless you have a truly exceptional manager or if it is a fund that gives you exposure to some esoteric market that doesn't have a good index proxy that you can invest in. Also, very importantly, pay attention to the pass-through capital gains that are generated when the fund liquidates positions where they have made a profit. These gains get passed on to you and you have to pay, depending on the situation, either 15% or your highest marginal tax rate. One would be wise to sack fund managers who are not tax efficient.

Disclaimer: I do not own positions in any of these funds. Any advice given here is not to be taken as professional financial advice.

Tuesday, October 19, 2010

And for a brief moment of levity...

If you feel that you are behind on your rent and that is preventing you from accumulating sufficient wealth to save and invest, this man is for you:

Edit: Incidentally, this man is also right. Look at New York City rents: http://www.tregny.com/manhattan_rental_market_report

When good isn't good enough

Apple (AAPL) probably now has produced one of the classic examples of "buy the rumor, sell the news" I've ever seen. Its earnings report blew away all estimates by wide margins on earnings per share and revenues. Its forecast was a little weak, but then again Apple always guides low. Causing this sell-off is the fact that iPad sales were weaker than estimated and the suspicion that the forecast might indicate a slowing in growth. I would not go so far as to say that this decline represents a buying opportunity because, even with its growth rate, Apple shares still trade at a premium to the overall market that is large enough that it warrants caution. At this valuation, there is very little room for error and this sell-off reflects that.

Now, you might wonder why I took a screenshot. The reason is that the change in the stock price after a mixed bag of an earnings report like that one is subject to a great deal of volatility. It could be that eight hours from now any comments about Apple's sell-off might be moot.

Monday, October 18, 2010

Physics and Stocks?

So some physicists decided to try and predict the stock market movements and they found that they could predict with 80% confidence the movement of the Dow with...


Apparently the "calmness" of Twitter had the highest correlation. However, they had no explanation, just a correlation, so I'm not ready to start investing based on Twitter. But, this could be a new way to look at investor sentiment.

If you want to read a more thorough analysis of the paper, check out http://www.technologyreview.com/blog/arxiv/25900/?ref=rss

Stock Options Teaser

Because I've only finally gotten my brokerage account upgraded to allow for options trading, I felt that I should talk some about stock options. Before I do, here's the relevant Wikipedia article for those not versed on the subject: http://en.wikipedia.org/wiki/Option_(finance)#Trading

About those moves toward protectionism...


This is more along the lines of anti-immigrant rhetoric, but I always look at these sorts of things as part of the same overall package. Countries that wish to shut their borders to immigrants because they make immigrants a scapegoat for their problems are only a couple steps away from blaming foreign competition as well. In Germany, that would be a bit of an odd case, but it isn't implausible. I'm still wondering if and when we will see a major country send its trade barriers on up.

Friday, October 15, 2010

Mr. T Pities the Fool Who Doesn't Buy Gold


I think this, and the ever shifting series of justifications for gold (including arguments that it is your hedge against inflation, deflation and prosperity all at once) are beginning to flash big warning signs that gold is about to top out and possibly top out for some time to come.

Blogger Barry Ritholtz, who is a far more esteemed observer of financial markets than I, argues for maybe having 5% of your total liquid assets in gold or precious metals more broadly. I can't say that I'm entirely opposed to that proposition, but I think the issue here is the entry point. While no one has ever developed either a good empirical or theoretical framework for valuing gold, the odds are that gold has seen its best days for some time to come.

Oh those inflation hawks...

0.1% headline CPI and 0.0% core: http://www.bls.gov/news.release/cpi.nr0.htm

Yep, that inflation's out of control...

Wednesday, October 13, 2010

MBA Purchase Index and Early Read on September Home Sales

From Calculated Risk we see a couple of interesting tidbits on housing. First, the weekly MBA purchase index had a rough week, dropping 8.5%. There's apparently a change in FHA standards related to this. Does anybody happen to know what that is?

Then, September home sales seem to have picked up a bit from August. A 4.5 million SAAR will register as a big percentage increase, but in truth that's still a horridly weak number and will leave inventories at the point where price reductions are likely. Inventories much above 8 months of sales usually lead to some measure of price reductions. 

Still, combine this with auto sales that were slightly up and decent retail sales and we at least aren't seeing the relapse in consumer spending many had feared. From the larger perspective, I'm still not seeing the evidence of a double-dip in the broad economy.

Saturday, October 9, 2010

Is the market cheap or expensive right now?

I'm not going to cop out and say it depends (though what methodology you use matters). I'm just going to come right out and say that it looks slightly undervalued overall.

This headline "S&P 500 Profits Cut First Time in Year by Analysts" should give some pause because I don't like it when earnings upgrades give way to downgrades while the market is struggling to make gains. That generally signals some warning signs. However, there is a fair amount of cushion regarding earnings estimates. The article states that S&P 500 earnings estimates were cut from $96 to $95 for the S&P 500. That's based on a "share" of the S&P 500 if you view the index level as a price. So then, the basic calculation is made with the S&P 500 trading at 1165 and earnings at $95 the S&P 500's PE ratio is a whopping 12.26x. Not exactly a historic high. As such, estimates could be cut a great deal and the market still would be in decent condition from a valuation perspective.

An annoying post from Mish's Global Economic Trend Analysis references the 1970s where, as market historians know, the stock market failed to advance throughout the decade. The S&P 500's PE ratio entered the decade at around 16x and left at under 7x, representing severe multiple contraction. However, if you look at long term interest rates, as we have in previous posts comparing the relative attractiveness of bonds to stocks, this makes sense. 10-year treasury rates rose from around 7% to as much as 12.75% by March of 1980 (the same month cited in that post) and then up to a high of over 15% by 1981. If you look at the comparative earnings yields and interest rates, you have stocks at 6% or so at the start of the decade with 7% on treasuries. In 1980 you have stocks at 14% (approximately) and bonds at nearly 13%. I rounded a fair amount here because I am feeling lazy, but the post I'm responding to was even lazier.

Currently, by the same comparison, stocks at a forward earnings yield of 8.15% (not the same comparison, but let's use it for now) and the ten year treasury is at 2.39%. Depending on your metric, you might use the ten year trailing PE ratio, which puts us at 21x earnings, or the one year trailing which seems to be more like 15x (depending on what is included in trailing earnings). In any case, unless interest rates start rising a great deal, which is highly unlikely, the outlook for stocks is fairly constructive at the moment.

Edit: I just remembered that we had an earlier discussion about whether or not the spread between earnings yield and interest rates is a good predictor of future returns. Generally it isn't, but the relevant comparison is whether or not it is useful for selecting between stocks and bonds which offers the best return and on that count it performs reasonably well.

Monday, October 4, 2010

Not a good bathroom to do Coke in

Here's a question for the people who are smarter than me. What happened with Coca-Cola Enterprises (CCE) today? I understand they gave North American bottling operations over to Coca-Cola Co. (KO), but I guess I'm confused about how the dividend payout caused the immediate drop in the price of the stock.

In addition, my first inclination was to just leave it alone. But with CCE taking complete control of bottling operations in Europe, is it reasonable to expect that their stock will grow at a relatively predictable rate? Or maybe eastern europeans hate coke?

Sunday, October 3, 2010

Checking in With the Mortgage Bond Insurers

In the interest of maintaining accountability on calls recommended on this site, here is a brief update on the performance of the mortgage bond insurers since they were thoroughly examined on July 22nd.

Well, I recommended MGIC (MTG) at that time and it has merely been second best, trailing MBIA (MBI) by a fairly wide margin. Clearly, MBIA has been on fire, even with a slight recent pullback. Ambac and Radian have been disasters while PMI has held in there, very closely tracking MGIC, much to my surprise.

Asset Allocation Model and Rebalancing

There are some thrilling Sunday conversation topics for you.

In any case, I realized that I neglected to post what the asset allocation model said for September. Suffice it to say that it still points toward the same 80/20 split in favor of equities that it has since we have been modeling it. However, after the increase in stock prices in September and a slight narrowing of corporate credit spreads, the overall score wasn't quite as strong. Remember that the model has minimum asset allocations of 20% bonds or equities no matter how favorable the indicators become for one asset class or another.

In any case, now might be a good time to discuss that even with fixed asset allocations like this there are some nuances that you have to take into account regarding re-balancing. If you rebalance every month where you assess your actual allocations compared to the targets, a result many don't think of is that, even with static asset allocations, you do end up accumulating more of the underperforming asset class at its bottom. I've actually gotten some confused looks from people on this point so I will explain it in a clear example.

For example, let's say that you have $100,000 (most of us wish) split 80/20 stocks and bonds respectively. In the course of three months, the stock portion of your portfolio loses 25% and the bond portion rises 10%. You will have a total of $82,000 split $60,000 stocks and $22,000 bonds. Inadvertently, bonds have become about 27% of your portfolio. In order to bring your portfolio back into the proper balance, you take $5,600 out of your bonds and put it into your stock positions to restore your target weightings. In this way, even when your portfolio takes an overall beating due to possibly being overexposed to equities in a bad stretch for them you still buy in at the lows even though it would otherwise appear that you can't commit any more to equities. This isn't exactly a shocking revelation, but it is one that some people don't think of.

Now, if you have a $5,000 portfolio or even a $10,000 portfolio as opposed to a $100,000 portfolio, the transaction costs involved here probably either come close to or entirely eliminate the gains from very frequent rebalancing. If you rebalance every month, you have two transactions at $10 a piece for $240 in a year, not to mention the capital gains you might accumulate in the process. This is one persistent problem for smaller portfolios versus larger ones which is that you are more wedded to individual investment decisions due to a lack of flexibility in getting out of them.