Monday, March 30, 2009

value stocks in a recession

Contrary to popular belief, value strategies often do poorly during recessions, especially relative to growth strategies.

The reason is simple: When growth is scarce, as it is in a recession, then investors pay a premium for companies that manage to keep growing. One memorable exception was the recession of 2001, when investors dumped growth companies -- mostly overpriced technology stocks -- as if they were toxic.

"It's not unusual for value to suffer in a recession," says Joseph Mezrich, head of quantitative research at Nomura Securities International. "What's unusual this time is the magnitude" of the suffering.

In this recession, the value-stock barrel has been spoiled mainly by a bunch of very bad apples: banks.

Value investors often hunt for companies that have a low ratio of stock price to "book value," which is roughly the value of their assets minus their liabilities. For various reasons, banks typically have very low price-to-book ratios, so they often turn up on the radar screens of value investors.

When the banks started taking heavy losses in late 2007 on mortgage bets gone bad, their share prices fell, which made their price-to-book ratios even lower, making them even more irresistible to value investors.

The trouble was the "book" part of that ratio: Trillions of dollars of the assets on bank balance sheets were tied up in mortgage debt, which was rapidly declining in value. That made book value a target that was moving fast in the wrong direction: down.

And that meant the stocks weren't nearly the bargains they seemed and just kept falling -- a phenomenon some analysts call a "value trap."

Saturday, March 28, 2009

Dow in 2010

Reread an old OID from July 31, '00 in which Jeremy Grantham summed up his four-year study of 200 years of bubbles in 38 different markets in various countries __stocks, bonds, commodities, real estate. Said every bubble, without exception, gave up 100% of its gains in the bubble period. Now, he was kind of vague on defining how he measured when a bubble started.

The point of interest to me. He tried to figure out where the S&P 500 would be in 2010 with mildly generous assumptions, rather than crazy bubble assumptions (p/e = 32 when he wrote). "We assume a P/E of 17 1/2 (up from the historical average of 14) and a profit margin of 6% (up from the actual historical average of 5.5%). Incidentally we assumed annual sales growth of 4% per year, although we actually believe the figure will be closer to 2%, The long-term trend has been only 1.8%. We're putting in 4% only because our clients can't stand anything less...The return contribution from the yield is 2.2% per year...It gets me to a total return of a negative 1.9%...If I assume 2% sales growth instead, I arrive at an estimated return of neagtive 3.9% per year. That starts to get more like it __closer to reality."

Later, he gives a more negative, but far from crazy, scenario. P/E = 12.6. Profit margin 5.2. Sales growth 1.6. Dow in 2010 = 3,600.

Jeremy also said that for the S&P and Nasdung to trade at fair value the S&P would have to go down -53% and the Nasdaq -70%. Pretty close.

What to buy in '00? Real estate. (Also, timber, inflation-protected bonds, emerging equity and debt.)

Interesting.

"Were we to return to the figures that prevailed in 1982 __perish the thought__ Dow = 1,450."

Grantham never specifically says, but I assume his starting point is the S&P level on 1/1/00 = 1469.25. If so, the S&P is down -35.6%. Or about -4.9% CAGR. Or is that Compound Annual Shrink Rate. Throw in even 2-3% inflation and real returns the last 8 3/4 yrs have been awful. Pretty close reckoning, JG.

[from russ_21401, 10/16/08]

How will the bear market end?

During bear markets, especially ones as severe as the current downturn, the obvious temptation for investors is to reduce their allocation to stocks and move into the safety of cash. A common refrain from investors is that they will "wait until things get better" to restore their allocation to stocks at a level that is consistent with their longer-term investment strategies. The criteria for improvement often implies the investor will hold out for some positive news about the economy, or possibly wait for the market to start rising again in a more sustained manner.

While this strategy may sound reasonable at a time when stock markets continue to decline and investors take comfort from avoiding losses, the flaws are exposed when the bear market comes to an end. As noted, the market tends to rise six months before the economy stops contracting, so waiting for good economic data to hit the headlines inevitably means missing out on the early stages of the rally. Of course, waiting for the stock market to go up as a signal of the end of the bear market also necessarily means an investor has to sit on the sidelines while a new bull market begins.

This pattern of investor behavior, and its pitfalls, can be demonstrated looking at the end of the 2000-2002 bear market (see MARE article, The Perils of Herding to Cash). Investors moved into a record-high cash position by the end of 2002, during the exact period when the U.S. stock market was bottoming after a three-year downturn (see Exhibit 2.) It took investors roughly until February 2004 -- 15 months after the end of the bear market -- to reduce their cash position back to an average level, during which time many had missed out on the stock market's return of more than 30% during the simultaneous bull market rebound.

Thursday, March 26, 2009

Kass gives the green light

10 out of 12 factors (including our newest, market internals) on my watch list are in an improving mode. Though many variables are currently accorded relatively low grades and the outlook remains debatable, the delta (rate of change) in almost my entire watch list is improving and flashing a green light for the U.S. stock market.

Margaritaville

Randy steps forward with a solution to fix the desperate state of the economy.

[via Edmonton]

new home sales rise as prices fall

The new home sales report for January showed that sales rose 4.7% month-over-month (m/m) to 337,000 units on an annualized rate, better than the expectation of a fall of 2.9% m/m to 300,000 units. Year-over-year (y/y), new home sales fell 41%. Inventory of new homes for sale fell to 330,000, comprising 12.2 months worth of sales, much higher than the 5 to 6 months that is considered a stable market. The median price of a new home fell 18% year-over-year, to $200,900, the biggest y/y drop since records began in 1964.

[Schwab Alerts, 3/25/09]

Mauldin retorts

I opened the Wall Street Journal and read that new home sales were up in February. Bloomberg reported that sales were "unexpectedly" up by 4.7%. I was intrigued, so I went to the data. As it turns out, sales were down 41% year over year, but up slightly from January.

But if you look at the data series, there was nothing unexpected about it. For years on end, February sales are up over January. It seems we like to buy homes in the spring and summer and then sales fall off in the fall and winter. It is a very seasonal thing. If you use the seasonally adjusted numbers, you find sales were down 2.9% instead of up 4.7%. But the media reports the positive number. Interestingly, they report the seasonally adjusted numbers for initial claims, which have been a lot better than the actual numbers. Not that they are looking to just report positive news, you understand.

[I suppose Mauldin has a point, but the main point is that the number reported was better than expected. Whether it was up or down is immaterial. Even if sales were actually down adjusted, it was still better than expected. Or is he saying the analysts were stupid for expecting a negative number?]

[4/1/09] Pending home sales for February rose 2.1%, higher than the Bloomberg estimate of flat month-over-month. This series has been volatile on a monthly basis, as represented by January's decline of 7.7%. Pending home sales are considered a leading indicator as they track contract signings. As Schwab's Chief Investment Strategist Liz Ann Sonders notes in her article located at www.schwab.com/marketinsight, Brighter Light at End of Housing Tunnel, sales and traffic of potential homebuyers has picked up, notably in areas where prior declines were most severe. While still at elevated levels, inventories have declined, and prices will likely have to fall another 10-15% before finding stability. However, if the pace of inventory declines continues, the light at the end of the tunnel should get brighter. [Schwab Midday Market View]

Tuesday, March 24, 2009

what hedge funds do best

Morningstar certainly selected a lively date to launch its initial batch of Morningstar Ratings for hedge funds: January 2008. One year later, hedge funds had suffered their worst 12-month performance in forever, dropping more than 20% in aggregate and spurring a wave of investor redemptions.

In response, hedge funds did what hedge funds do best--they quit. Folded shop, returned what assets remained, expired. They became ex-hedge funds. Either that, or they crawled into a cave to lick their wounds, continuing to exist but ceasing to be seen in daylight by refusing to update their performances in public databases such as Morningstar's. All in all, of the 1,732 single-strategy hedge funds that received a rating from Morningstar during the March 2008 launch, a whopping 615 funds--36%!--disappeared over the ensuing 12 months.

existing home sales unexpectedly rise

Existing home sales for February rose 5.1% month-over-month (m/m) to 4.72 million units on an annual rate, well above the expectation of a fall of 0.9% to a rate of 4.45 million units, after falling 5.3% in January. Year-over-year sales declined 4.6%. According to the National Association of Realtors (NAR), entry level buyers are bargain shopping, and therefore distressed sales, such as foreclosures, accounted for 40 - 45% of transactions in February. The NAR noted that their analysis shows that distressed homes typically sell for 20% less than the normal market price, which is drawing down the overall median price. The average price for existing homes for sale was $165,400, falling 15.5% from a year ago, the second-biggest drop on record. Inventories rose to 3.8 million existing homes available for sale from 3.6 million in January, and the supply represents 9.7 months of sales, up from 9.6 months in December. The NAR said that sales gains in the West were led by California, where "the median listing price is beginning to rise for the first time in three years." Home shopping activity nationally picked up after the $8,000 first-time buyer tax credit was put in place.

[3/23, Schwab Alerts]

Just As Bad

From the Weitz Funds Quarterly Report, December 31, 2008

On an historical note, at a time when the media makes regular references to the Great Depression and the bear market of the 1930’s, the Leuthold Group offers some interesting statistics. The average annual total return for the S&P 500 for the 10 years ended November 20, 2008 was -2.7%. This matches the worst 10-year performance in stock market history—1929-1939. So, we have just completed a 10-year period during which the stock market was just as bad as the 1929-39 market.

Also, according to Leuthold, roughly 5% of the ten-year periods since 1926, have produced S&P 500 returns of less than 1% per year for the ten years. Each of those flat-to-down markets was followed by a ten-year period of strong returns, ranging from 101% or 7.2% per year (Q4 1938 to Q4 1948) to 325% or 15.6% per year (Q3 1974 to Q3 1984).

Defensible?

I found this blurb interesting while glancing through the GAMCO Growth, 9/30/07 report. (Not to pick on Howard Ward or anything.)

As of this writing, the S&P 500 is at about 1500, resulting in a price/earnings (P/E) multiple of 15.8 times the ’07 estimate and 14.9 times the ’08 estimate. These numbers have changed a little for the better in the past 3 months and are close to the long term average P/E. Barring a recession, stock valuations appear quite defensible.

So what happened? The P/E hasn't changed that much, but evidently earnings have been crushed falling far short of the estimates.

Thursday, March 19, 2009

Cramer's worst case

Cramer's worst case scenario using bottoms-up analysis. Dow 5320.

In other words, he can't envision the Dow going below 5320. (So he's actully saying we must be pretty close to the bottom and that's bullish to me.)

Wednesday, March 18, 2009

Bernanke sees end of recession

America's recession "probably" will end this year if the government succeeds in bolstering the banking system, Federal Reserve Chairman Ben Bernanke said Sunday in a rare television interview.

In carefully hedged remarks in a taped interview with CBS' "60 Minutes," Bernanke seemed to express a bit more optimism that this could be done.

Still, Bernanke stressed -- as he did to Congress last month -- that the prospects for the recession ending this year and a recovery taking root next year hinge on a difficult task: getting banks to lend more freely again and getting the financial markets to work more normally.

"We've seen some progress in the financial markets, absolutely," Bernanke said. "But until we get that stabilized and working normally, we're not going to see recovery.

"But we do have a plan. We're working on it. And, I do think that we will get it stabilized, and we'll see the recession coming to an end probably this year."

Even if the recession, which began in December 2007, ends this year, the unemployment rate will keep climbing past the current quarter-century high of 8.1 percent, Bernanke said.

A growing number of economists think the jobless rate will hit 10 percent by the end of this year.

Asked about the biggest potential dangers now, Bernanke suggested a lack of "political will" to solve the financial crisis.

He said, though, that the United States has averted the risk of plunging into a depression.

"I think we've gotten past that," he said.

When the financial crisis intensified last fall, Bernanke and President George W. Bush's Treasury Secretary Henry Paulson rushed to Capitol Hill for help. That led to the swift enactment of a $700 billion bailout package in October. Since then, banks have received billions in capital injections in return for government ownership stakes in them.

Looking back, Bernanke said the world came close to a financial meltdown. Asked how close, Bernanke responded: "It was very close."

Bernanke admitted that the Fed could have done a better job of overseeing banks. Critics say lax regulatory oversight contributed to the crisis.

Bernanke said he believes all the big banks the Fed regulates are solvent. Big banks won't fail under his watch, Bernanke said -- though, if necessary, the government should try to "wind it down in a safe way."

[via maverick@investwise]

Sunday, March 15, 2009

America ready to bite the dust?

David Roche, formerly an investment strategist at Morgan Stanley and now president of an independent consulting firm in London, authored an interesting piece in the October 2008 Far East Economic Review titled "Another Empire Bites the Dust." Roche's premise is that over the long term all empires and civilizations undergo a pattern of corruption: first the ideology loses sway, next the economic model falters, then the currency loses favor, and finally military power wanes. Roche's explanation is perhaps the most important aspect of the article: "Unsustainable living standards at the empire's core, which are enjoyed but not earned, depend upon flows of wealth from the periphery." In the current market environment, the "empires" are those countries in which, like the U.S., consumers spent briskly, regardless of the consequences, and the "peripheries" were those economies in which consumers saved more than they spent and leverage/personal debt was considered sinful.

-- from the Oakmark Equity and Income first quarter report

Thursday, March 12, 2009

Was 666 the bottom?

Was 666 the bottom? By now, practically everyone knows that the intra-day low we bounced from on Friday was our call for what the trough could possibly look like -- we had danced around this number for months but last reiterated it when the S&P 500 was hovering near 835 back in mid-February.

As we have said in the past, the S&P 500 index any moment in time is the construct of two numbers -- corporate earnings and the multiple that investors are willing to pay for that profit stream. We had been of the view that we could be at 666 by October under the caveat that a classic 12x recession trough multiple would be applied to a 2010 forward operating earnings forecast of $55.50.

But given that we are in March, and we still have to apply that multiple to 2009 earnings of $46, then we are talking about the prospect that we could actually see this market go as low a 550 before we hit bottom. That is not a forecast, but it is more than a remote possibility, in our view.

If we were to apply a blend of 2009 and 2010 earnings, we would be talking about a bottom of around 600. So in answer to the question whether 666 was an intermediate low or something more fundamental, at this stage, unless this recession is over by July, then in our view it simply cannot be that the bear market is over because bear markets end typically 4 months before the recession ends, or when we are two-thirds of the way through, take your pick.

This economic downturn began in December 2007; our internal compass now tells us that we are still barely halfway through, so conceivably, we may not be pulling out of the recession until we are well into 2010.

So with that in mind, it's hard to believe we are at the low unless our timing of the end to the recession is off base. That is always a possibility, but we simply don't see a light at the end of the economic tunnel just yet. We also have to respect the likelihood that the financials, which led the bear market by six months, will be the group that leads us out -- and considering that the S&P financials just hit a fresh 17-year low, we can say with some degree of confidence that the bottom to the overall market is probably at least six months away at this point.

One last item to consider is how bear markets like the one we are in have always ended -- they end when we break below what was universally perceived to have been the fundamental bear market low for the cycle, because that is the time that sentiment gets washed out once and for all.

For example, in the last cycle, the September 21st, 2001 low of 965 was widely viewed back then as having been the fundamental low, and when that low was broken on July 2nd, 2002, the S&P 500 sliced all the way down to 776 by October 9th like a hot knife through butter.

Go back to the early 1980s -- the 112 mark on September 25th, 1981 was supposed to hold. It didn't; it was shattered on February 22nd, 1982 and the ultimate low was turned in on August 12th of that year at 102. We went back five decades and found that in the five major markets over that span, all of them shared this pattern of having a low hold for a period of several months, and when that low was shattered, the S&P 500 on an average and median basis fell a further 20% until the real cycle low was achieved.

So 20% off that 752 closing low back on November 29th would imply 600 on the S&P 500 this time around or roughly another 10% downside from where we are today. Again, that is more of an observation than it is a forecast, and if there is a sprinkle of good news, it is that almost 95% of the bear market is over even if 600 is where we finally bottom out at.

Nicholas J. Shepard
International Equity Sales Trading,
Merrill Lynch, New York

[via investwise]

The Daily Show on CNBC

CNBC Gives Financial Advice

[via boilermaker75]

bear market veterans

The S&P 500 Index has fallen nearly 55% since Oct. 9, 2007--an outcome worse than that of any other bear market since 1929 (when the Dow Jones Industrial Average plummeted more than 80% in less than three years). But there have been some periods with results similarly gnarly to the most recent drop, including the bear market that began in January 1973, which ultimately saw the S&P 500 fall nearly 50%. Granted, there were some other differences back then, including higher inflation and a drawn-out decline. (It's been faster this time around.)

Still, we wondered if funds led by portfolio managers that ran money in the 1970s have been better off in the latest downturn.

Morningstar identified twelve managers with tenures ranging from 32 years to 50 years. All lost money in the period from 10/9/07 to 3/9/07 with returns ranging from -29% to -50%. But all beat the S&P 500 which lost 55%. Looking at 10 year returns, 10 of the 12 beat the S&P 500 which returned an annualized -4%.

Today's economic report

Advance retail sales were down 0.1% in February, versus an expected drop of 0.5%, while January's advance was revised from 1.0% to 1.8%. Ex-autos, sales rose 0.7%, well above a projected decline of 0.1%. January was revised from 0.9% to 1.6%. If gasoline, autos, and building materials are removed, sales at retailers increased 0.5%, indicating that consumers have relatively stepped up spending for the second-straight month of the year despite the headwinds of the recession. The increase in spending is likely due to the pronounced weakness in holiday spending, and is likely the outcome of pent-up demand and discounted prices, where consumers shut down spending in 4Q in response to the shock of plunging stock portfolios and rapidly increasing job losses, and are out spending on the margin.

The stabilization of consumer spending is a positive, and if the trend continues it will likely be positive for manufacturers, who have been struggling to cut production fast enough to keep up with shrinking demand. However, we are unlikely to experience sustained rising consumer spending in the face of a deteriorating labor market and unhealthy consumer balance sheets. As Schwab's Chief Investment Strategist Liz Ann Sonders, and Director of Sector Analysis, Brad Sorensen, CFA, note in their bi-weekly Schwab Market Perspective: Depression/Recession-Does it Matter? consumers are spending less in order to save more to reduce debt, build their retirement accounts back up, and increase their emergency savings to protect themselves in case of future job loss. We need to ratchet down the copious and oftentimes unsustainable debt we ran up during the past few years, which will take discipline and time. Read more on their market perspective at www.schwab.com/marketinsight.

Weekly initial jobless claims rose 9,000 to 654,000, versus last week's figure that was upwardly revised by 6,000, and above the Bloomberg consensus which called for claims to rise to 644,000. The four-week moving average rose 6,750 to 650,000, and continuing claims jumped 193,000 to 5,317,000. Treasuries gave up early gains and are slightly lower.


US Treasury Secretary Timothy Geithner is testifying before the Senate Budget Committee on the Obama administration's 2010 budget proposal. Geithner reiterated that the Obama administration is projecting a $1.75 trillion federal budget deficit for the current fiscal year and that it is determined to cut the deficit by half in four years. The Treasury Secretary said short-term deficits are necessary to combat a recession as well as strains in financial markets. He also noted that the US financial rescue "might cost more" than the $700 billion already approved by congress.

Liz Ann Sonders, and Brad Sorensen note in their bi-weekly Schwab Market Perspective that the Obama administration continues to throw multiple plans at the credit crisis in an attempt to stabilize lending. Unfortunately, the response of the market has been less than enthusiastic as credit spreads have stopped narrowing for the time being-with some even disconcertingly reversing direction. After the $787 billion stimulus package failed to excite investors, and the housing plan left something to be desired, the administration's proposed budget further ignited concerns regarding increased deficits in the future. Additionally, the budget proposal was broad in its scope of extending the reach of government, which added to the uncertainty. This followed previous disappointments coming from the new governmental leaders, helping lead to the market reaction and lack of confidence that we're seeing.

where's the love?

Schwab researchers have examined the performance of analysts’ recommendations over a long period of time. We’ve found that the stocks rated best by analysts (what we’ll call “loved” stocks) have returned only 5.4% per year, averaged over the period from 1994 through 2008. But the worst-rated stocks (“unloved” stocks?) returned 10% per year over the same period.

The Worst Year?

The year 2008 may have been the worst calendar year in the entire history of the US stock market.

An investment in the S&P 500 lost 37% last year on a total return basis. Although 1931 looks worse on paper (a drop of 43%), that was also a year in which the consumer price level declined significantly, and since we have to buy goods and services at the prices being charged, calculations of return should be adjusted for inflation (or deflation, when it occurs).

By that measure, both 1931 and 2008 resulted in 37% losses in wealth, and whether one or the other was slightly worse is debatable, since calculations of inflation are neither precise nor the same for each person (since we all buy different things with our money). Let's just say it's a tie.

[Less Antman via velcher via chucks_angels]

a contrarian contrarian strategy

A small-cap contrarian approach following the last recession would have paid off handsomely, turning a $10,000 investment into nearly $30,000 in just five years. Not only did the most beaten-down small caps outperform their spared peers, but also, every quintile of small caps outperformed every quintile of large caps over the following five years.

Wednesday, March 11, 2009

Buffett's sell strategy

What was Mr. Buffett’s sell strategy? It was to buy when everyone else was focusing on selling! That is probably the most important lesson to be gleaned from his annual report. As he put it: “Pessimism is the friend of the long term investor, euphoria the enemy.”

So, Mr. Buffett didn’t sell anything in the face of such a relentless bear? Actually, he confessed to trimming his positions in Procter & Gamble and Johnson & Johnson in 2008’s fourth quarter. But, this, according to him, was so he could buy securities in General Electric and Goldman Sachs.

This type of move really underscores his investment philosophy. Not only was he investing in the most volatile part of 2008, October and November, he was rebalancing his portfolio away from what was generally perceived to be the only safe areas of the market, health care and consumer nondurables, into financials and industrial cyclicals.

The bottom line is Mr. Buffett espouses a contrarian investment philosophy. Not only is he buying, not selling, when markets are declining, but he’s buying in some of the most beaten down areas, financials and industrials, while lightening up in those sectors in which others are seeking a safe haven.As Mr. Buffett put it: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

Japan’s Stimulus is a Lesson

HAMADA, Japan — The Hamada Marine Bridge soars majestically over this small fishing harbor, so much larger than the squid boats anchored below that it seems out of place.

And it is not just the bridge. Two decades of generous public works spending have showered this city of 61,000 mostly graying residents with a highway, a two-lane bypass, a university, a prison, a children’s art museum, the Sun Village Hamada sports center, a bright red welcome center, a ski resort and an aquarium featuring three ring-blowing Beluga whales.

Nor is this remote port in western Japan unusual. Japan’s rural areas have been paved over and filled in with roads, dams and other big infrastructure projects, the legacy of trillions of dollars spent to lift the economy from a severe downturn caused by the bursting of a real estate bubble in the late 1980s. During those nearly two decades, Japan accumulated the largest public debt in the developed world — totaling 180 percent of its $5.5 trillion economy — while failing to generate a convincing recovery.

Now, as the Obama administration embarks on a similar path, proposing to spend more than $820 billion to stimulate the sagging American economy, many economists are taking a fresh look at Japan’s troubled experience. While Japan is not exactly comparable to the United States — especially as a late developer with a history of heavy state investment in infrastructure — economists say it can still offer important lessons about the pitfalls, and chances for success, of a stimulus package in an advanced economy.

In a nutshell, Japan’s experience suggests that infrastructure spending, while a blunt instrument, can help revive a developed economy, say many economists and one very important American official: Treasury Secretary Timothy F. Geithner, who was a young financial attaché in Japan during the collapse and subsequent doldrums. One lesson Mr. Geithner has said he took away from that experience is that spending must come in quick, massive doses, and be continued until recovery takes firm root.

Moreover, it matters what gets built: Japan spent too much on increasingly wasteful roads and bridges, and not enough in areas like education and social services, which studies show deliver more bang for the buck than infrastructure spending.

“It is not enough just to hire workers to dig holes and then fill them in again,” said Toshihiro Ihori, an economics professor at the University of Tokyo. “One lesson from Japan is that public works get the best results when they create something useful for the future.”

Billionaires are down too

Like the rest of us, the richest people in the world have endured a financial disaster over the past year. Today there are 793 people on Forbes list of the world's billionaires, a 30% decline from a year ago.

Of the 1,125 billionaires who made last year's ranking, 373 fell off the list -- 355 saw declining fortunes, and 18 died. There are 38 newcomers plus three moguls who returned to the list after regaining their 10-figure fortunes. It is the first time since 2003 that the world has had a net loss in the number of billionaires.

Microsoft's Bill Gates lost $18 billion but regained his title as the world's richest person. Warren Buffett, last year's No. 1, saw his fortune decline $25 billion as shares of Berkshire Hathaway (BRK.A, news, msgs) fell 40% in 12 months, but he still managed to slip just one spot, to No. 2. Mexican telecom titan Carlos Slim Helú, No. 2 a year ago, also lost $25 billion and dropped to No. 3.

Tuesday, March 10, 2009

Roubini is depressing

For those who argue that the rate of growth of economic activity is turning positive--that economies are contracting but at a slower rate than in the fourth quarter of 2008--the latest data don't confirm this relative optimism. In 2008's fourth quarter, gross domestic product fell by about 6% in the U.S., 6% in the euro zone, 8% in Germany, 12% in Japan, 16% in Singapore and 20% in South Korea. So things are even more awful in Europe and Asia than in the U.S.

With economic activity contracting in 2009's first quarter at the same rate as in 2008's fourth quarter, a nasty U-shaped recession could turn into a more severe L-shaped near-depression (or stag-deflation). The scale and speed of synchronized global economic contraction is really unprecedented (at least since the Great Depression), with a free fall of GDP, income, consumption, industrial production, employment, exports, imports, residential investment and, more ominously, capital expenditures around the world. And now many emerging-market economies are on the verge of a fully fledged financial crisis, starting with emerging Europe.

Japan at 26 year low

Stocks in Asia were lower as financial fears continued to pressure sentiment. Hong Kong's Hang Seng Index led the decline, falling 4.8%, and Japan's Nikkei 225 broke through its October low to finish at the lowest level in 26 years. Adding pessimism to trading in Japan, the country reported the widest-ever current account deficit as the first deficit since 1996 came courtesy of a sharp contraction in exports due to the struggling global economy and a stronger yen.

[3/9, Schwab Center for Financial Research - Market Analysis Group]

Sunday, March 08, 2009

"Safe" Dividend Aristocrats

Dividend Aristocrats are S&P 500 issues that have either paid increasing annual cash dividends for the past ten years or increased cash dividends for 20 of the last 25 years.

S&P also identifies those that have increased their dividends for 25 straight years. And have earnings at least twice their dividend rate.

The following are those that qualify in all categories.

3M
Abbott Laboratories
Aflac
Archer-Daniel Midland
Bard (C.R.) Inc
Becton Dickinson
Chubb Corp
Dover Corp
Emerson Electric
Exxon Mobil
Family Dollar
Grainger (W.W.) Inc
Johnson & Johnson
Lowe's Companies
McGraw-Hill
Pepsico
Procter & Gamble
Questar
Sherwin-Williams
Sigma-Aldrich
State Street Corp
Target
VF Corp
Walgreen
Wal-Mart

[via chucks_angels]

Four Bears (update)

As of this writing, the current bear market has surpassed the 1973-1974 (oil crisis) bear market and the tech crash of 2000-2002 in magnitude. Those lost 48% and 49% peak to trough respectively. The current bear has lost 56% so far.

It has now matched almost exactly the 1929-1932 crash 17 months into the bear. But the 1929-1932 crash went on to last a total of 34 months and lost a total of 89%.

[chart via chucks_angels]

Barron's calls the bottom

One of these days, one of these guys will correctly call the bottom. It's Andrew Bary's turn in the Barron's cover story.

* * *

The brutal bear market of the past year has affected all industry groups and nearly every stock. All 30 members of the Dow Jones industrials are in the red for the past 12 months and just one stock, IBM (IBM), is in the black for 2009. Within the S&P 500, just eight stocks are higher in the past year, led by Family Dollar Stores (FDO), which has gained 56%. The worst performer in the S&P 500: AIG (AIG), which is off 99%, to just 35 cents.

Sure, stocks could slide much further -- but they probably won't. By most measures, they are downright cheap.

AFTER THE STUNNING DECLINE OF THE PAST FIVE months that has left the Dow Jones Industrial Average and Standard & Poor's 500 Index more than 50% below their 2007 highs, a lot of investors are worried stocks could fall much further.

In a worst-case scenario, based on current earnings estimates and the most pessimistic reading of market history, the Dow could fall a further 25%, to 5000, and the S&P could drop to about 500. The Dow industrials closed at 6,627 Friday, and the S&P 500 ended at 683, both down 24% so far this year and both at 12-year lows.

The lousy economy is the main factor, but stocks haven't been helped by Obama administration proposals that would hurt a range of companies, including drug makers, managed-care firms and student-loan providers. Investors also haven't liked the president's plan to raise taxes on the wealthy. It doesn't help that the Street is calling this an "Obama bear market" and that some investors are looking to "Obama-proof" their portfolios, avoiding sectors targeted by the president.

However you feel about President Obama, he got at least one thing right last week: He said stocks are cheap for long-term investors. Our research shows that to be true, whether you look at stocks relative to book value, U.S. economic output, gold or a normal level of corporate earnings.

These factors, plus the huge amounts of cash now sitting on the sidelines, suggest that, barring a global economic and financial meltdown, the Dow should bottom well above 5,000 and the S&P Index well above 500.

It is tough to predict this year's corporate profits because of the deepening global downturn and potential likelihood of little or no earnings in the U.S. financial sector. Citigroup financial economist Steve Wieting sees $51 in operating profits for the companies in the S&P 500 this year before big write-downs, down from $66 in 2008. Based on his estimate, which is in line with the current Wall Street consensus, the S&P 500 is valued at more than 13 times projected 2009 profits.

THAT PRICE/EARNINGS MULTIPLE is in line with the lowest levels hit during most bear markets over the past 80 years. Key exceptions were 1974, 1982 and 1987, when the S&P 500 was valued at about 10 times forward earnings, according to Goldman Sachs. If stocks do get to a P/E of 10, the S&P 500 could drop as low as 500, a decline of more than 25% from current levels, and the Dow Jones Industrial Average could drop toward 5000.

This scenario seems extreme, however, because prior market lows occurred during periods of higher inflation and interest rates, decreasing the relative appeal of stocks. Treasury yields, for instance, were in the double digits in 1982, against 2% or 3% now.

Saturday, March 07, 2009

undervalued, cheap, (and going down?)

I'm looking through some old mail in my deleted folder and came across this Morningstar article dated 10/8/08 titled The Market's Most Undervalued Stocks (These five high-quality companies are truly cheap).

These were stocks with Morningstar ratings of 5 stars and trading at less than half of their fair value estimate.

The stocks named were USG, UNH, COP, NWS, EXPE.

Let's see how they have done.
      10/8/08  3/6/08  loss%
USG 19.85 4.29 78%
UNH 19.20 17.90 7%
COP 60.77 35.36 42%
NWS 10.06 6.00 40%
EXPE 12.96 6.47 50%
The Vanguard 500 (I chose this instead of the S&P 500 because Yahoo has an adjusted close which accounts for dividends) has gone from 89.96 to 63.96 or a loss of 29%. So four out of the five stocks have underperformed the index.

Which tells me just because it's good and cheap doesn't mean it won't go down a lot. (Now let's see how they do on the upside -- if we ever get an upside one of these days.)

* * *

Yet Morningstar maintains that (Graham-style) value investing protects the downside. (Does that mean Morningstar doesn't practice value investing?)

Thursday, March 05, 2009

World's safest banks

International banks dominate the rankings in a new report on the safest financial institutions worldwide, with San Francisco's Wells Fargo & Co. coming in as the safest U.S. bank.

According to Global Finance , the analysis of the “World’s 50 Safest Banks” shows the effects of the subprime mortgage meltdown and credit crisis brought on by large Wall Street players. European banks now dominate the rankings, with only four U.S. banks among the listing.

Wells Fargo (NYSE: WFC) — which recently merged with Wachovia Corp. —was ranked No. 21, followed by US Bancorp (NYSE: USB) at No. 26, The Bank of New York Mellon (NYSE: BK) at No. 35 and JPMorgan Chase & Co. (NYSE: JPM) — which has merged with Washington Mutual Inc. — at No. 47.

Four German banks were ranked in the Top 10, with state-owned development bank KfW Bankengruppe at No. 1.

Tuesday, March 03, 2009

money on the sidelines

At the end of November 2008, money market fund assets surpassed stock fund assets for the first time in at least 11 years. This situation came about as a result of equity market declines and high levels of risk aversion. There have been two months of data released since then, with January data (released last Thursday) demonstrating that high money market and cash levels remain. Total stock fund assets are now at their lowest point since September of 2003, as continued declines in equities erode the total value of holdings. Money market fund assets continued to grow, making new highs as investors continue to put money in the safest of assets. This comes as treasury yields hang around historically low levels. Another indicator of continued risk aversion is the portion of stock fund assets that are in liquid assets or cash. Liquid assets in mutual funds as a percentage of total assets jumped to new highs in January to 5.8%, the highest since March 2001, suggesting that money managers are hoarding cash while equity markets trade at the lowest levels seen since the late 90's.

[via iluvbabyb]

* * *

[I couldn't find a link to the above (it's supposed to have come from briefing.com), but here's some supporting evidence that money fund assets are high]

Many investors are peculiar in the sense that they have most of their money in equities when markets are near tops but have little exposure when markets are at their lows. With the S&P 500 having declined substantially in 2008, there is currently a huge amount of money waiting on the sidelines. US Money Market Funds assets recently increased to US$3.7 trillion (as at 26 November 2008), which is 35% of the total US market capitalisation.

Historically, the US Money Market Assets to US Equity Market Capitalisation proportion has stood at 15%, intuitively increasing when equity markets suffer sharp losses (See Chart 3). This ratio recently reached a new historical high of 39.2% on 19 November 2008, not only due to the decline in the equity market but also due to new inflows of cash into money market instruments. In comparison, the ratio spiked to 26% at the last market bottom in October 2002.

* * *

[but the flow out of stock funds may be starting to reverse???]

Investors in stock mutual funds added modestly to their portfolios in January, reversing seven straight months of net redemptions, according to data released today by Strategic Insight Mutual Fund Research and Consulting LLC of New York.

Despite sharply falling stock prices last month, stock fund positive flows reached $7 billion, according to estimates from Strategic Insight’s Simfund database. Inflows were experienced in U.S. stock funds ($5 billion) and international equity funds ($2 billion).

Also during January, mutual fund investors purchased $21 billion of taxable bond funds, with all key sectors showing gains, and more than $3 billion of tax-free bond funds.

Money market mutual funds benefited from more than $64 billion of net inflows, as money fund assets rose to another record of almost $4 trillion.

* * *

[4/22/09 from E*Trade] Not surprisingly, the long and painful bear market has pushed a lot of money to the sidelines. At the end of 2008, cash in money markets and bank accounts had reached nearly $9 trillion or 74% of the value of all publicly traded stocks in the U.S.!

That was the highest such ratio since 1990 — and it would only take a portion of that money moving back into the market to have a powerful effect on stock prices.

The formula that killed Wall Street

A year ago, it was hardly unthinkable that a math wizard like David X. Li might someday earn a Nobel Prize. After all, financial economists—even Wall Street quants—have received the Nobel in economics before, and Li's work on measuring risk has had more impact, more quickly, than previous Nobel Prize-winning contributions to the field. Today, though, as dazed bankers, politicians, regulators, and investors survey the wreckage of the biggest financial meltdown since the Great Depression, Li is probably thankful he still has a job in finance at all. Not that his achievement should be dismissed. He took a notoriously tough nut—determining correlation, or how seemingly disparate events are related—and cracked it wide open with a simple and elegant mathematical formula, one that would become ubiquitous in finance worldwide.

For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril.

David X. Li, it's safe to say, won't be getting that Nobel anytime soon. One result of the collapse has been the end of financial economics as something to be celebrated rather than feared. And Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees.

[via aquarian]

Has the market bottomed?

These three Zacks guys didn't think so last week (2/25) (and they were right).

They were looking for something like a 20% drop from 7500 which would mean like Dow 6000.

a depression with a small d?

It may not be another Depression, but it might be another depression

By TOM RAUM and DANIEL WAGNER , Associated Press

WASHINGTON - A Depression doesn't have to be Great — bread lines, rampant unemployment, a wipeout in the stock market. The economy can sink into a milder depression, the kind spelled with a lowercase "d."

And it may be happening now.

The trouble is, unlike recessions, which are easy to define, there are no firm rules for what makes a depression. Everyone at least seems to agree there hasn't been one since the epic hardship of the 1930s.

But with each new hard-times headline, most recently an alarming economic contraction of 6.2 percent in the fourth quarter, it seems more likely that the next depression is on its way.

"We're probably in a depression now. But it's not going to be acknowledged until years go by. Because you have to see it behind you," said Peter Morici, a business professor at the University of Maryland.

No one disputes that the current economic downturn qualifies as a recession. Recessions have two handy definitions, both in effect now — two straight quarters of economic contraction, or when the National Bureau of Economic Research makes the call.

Declaring a depression is much trickier.

By one definition, it's a downturn of three years or more with a 10 percent drop in economic output and unemployment above 10 percent. The current downturn doesn't qualify yet: 15 months old and 7.6 percent unemployment. But both unemployment and the 6.2 percent contraction for late last year could easily worsen.

Another definition says a depression is a sustained recession during which the populace has to dispose of tangible assets to pay for everyday living. For some families, that's happening now.

Morici says a depression is a recession that "does not self-correct" because of fundamental structural problems in the economy, such as broken banks or a huge trade deficit.

Or maybe a depression is whatever corporate America says it is. Tony James, president of private equity firm Blackstone, called this downturn a depression during an earnings conference call last week.

The Great Depression retains the heavyweight crown. Unemployment peaked at more than 25 percent. From 1929 to 1933, the economy shrank 27 percent. The stock market lost 90 percent of its value from boom to bust.

And while last year in the stock market was the worst since 1931, the Dow Jones industrials would have to fall about 5,000 more points to approach what happened in the Depression.

... The current downturn has many of the 1930s characteristics, including being primed by big stock market and real estate booms that turned to busts, said Allen Sinai, founder of Boston-area consulting firm Decision Economics.

Policymakers and economists note there are safeguards in place that weren't there in the 1930s: deposit insurance, unemployment insurance and an ability by the government to hurl trillions of dollars at the problem, even if it means printing money.

Before the 1930s, any serious economic downturn was called a depression. The term "recession" didn't come into common use until "depression" became burdened by memories of the 1930s, said Robert McElvaine, a history professor at Millsaps College in Jackson, Miss.

"When the economy collapsed again in 1937, they didn't want to call that a new depression, and that's when recession was first used," he said. "People also use 'downward blip.' Alan Greenspan once called it a 'sideways waffle.'"

...Today's economic indicators don't project a depression. But Banerji is cautious. Economic data in 1929 didn't show that the stock market crash was about to lead to years of economic misery, either.

"It did not look like the kind of plunge that would be a depression until after the recession began," Banerji said. "The Great Depression didn't start out as a depression. It started out as a recession."

The depression that consumed most of the 1870s and followed something called the Panic of 1873 makes a better comparison to what's happening now, said Scott Nelson, a history professor at the College of William and Mary.

Financial markets had become centrally located by the 1870s, notably in London. And nations had not yet enacted the protectionist trade policies that were in place by the 1930s.

The results were not exactly promising. Gangs of orphans roamed city streets as men moved west to pursue cattle industry jobs. Widows struggled to make money by serving unlicensed liquor. Thousands of workers, many Civil War veterans, became transients.

The downturn lasted more than five years, according to the economic research bureau — four times as long as what the United States has endured so far in this downturn.

Today's recession is already longer than all but two of the downturns since World War II. But for now, public officials are being extremely cautious about the D-word. Alfred Kahn, a top economic adviser to President Carter, learned that lesson in 1978 when he warned that rampaging inflation might lead to a recession or even "deep depression."

When presidential aides asked him to use another term, Kahn promised he'd come up with something completely different.

"We're in danger," he said, "of having the worst banana in 45 years."

[via investwise]

Worst GDP Quarters

the stock market is taking it on the chin yet again, with the major averages taking out their November 20, 2008 lows. The Dow is now below the “psychologically important” 7,000 level, which is unleashing many headlines noting that it’s been cut in half since its high.

Since last fall, when there was a lot of hope expressed that the November lows would hold, we’ve reminded investors that market bottoms are processes over time, not moments in time. We still think this process will be less V-bottom like and probably more like what we experienced as the last bear market was ending. Recall the market sold off into the July 2002 lows, then rallied; then sold off again into the ultimate October 2002 lows, then rallied; and then again sold off into the pre-Iraq war lows of March 2003. It was only then that the market found its footing.

The pressure on the market currently feels a lot like 2002-2003, when every speckle of hope was dashed and the cycle of negativity continued. Many technical analysts kissed hope good-bye when the Dow broke 7,200 and the S&P 500 broke 740. Fundamental analysis isn’t helping either, of course, as the news is uncertain at best and dire at worst.

But history is full of examples of the stock market finding its footing while the economic news is most bleak. In fact, check out the table below, which ranks the worst 10 single quarters for GDP in history and shows how the stock market performed in the next year.

10 Worst GDP Quarters
Date (of Quarter) S&P 500 One Year Later
3/31/1958 32%
6/30/1980 15%
3/31/1982 37%
12/31/1953 45%
3/31/1949 15%
12/31/1960 23%
12/31/1981 15%
3/31/1975 24%
12/31/1970 11%
12/31/1957 38%
Average 25%

Source: Bureau of Economic Analysis, FactSet.

Note that in every case—even though GDP was at its crescendo low for the cycle—the stock market rebounded by double-digit percentages each time, with an average gain of 25%. What we don’t know, of course, is whether the fourth quarter’s -6.2% GDP will be the ultimate low for the economy, but history provides some reminders about the discounting nature of the stock market.

Monday, March 02, 2009

Dow dives below 7000

A relentless sell-off in the stock market Monday blew through barriers that would have been unthinkable just weeks ago, and investors warned there was no reason to believe buyers will return anytime soon.

The Dow Jones industrial average plummeted below 7,000 at the opening bell and kept driving lower all day, finishing at 6,763 -- a loss of nearly 300 points. Each of the 30 stocks in the index lost value for the day.

And the Standard & Poor's 500 stock index, a much broader measure of the market's health, dipped below the psychologically important 700 level before closing just above it. It hadn't traded below 700 since October 1996.

Investors were worried anew about the stability of the financial system after insurer American International Group posted a staggering $62 billion loss for the fourth quarter, the biggest in U.S. corporate history -- and accepted an expanded bailout from the government.

But beyond daily headlines, Wall Street seems to have given up the search for a reason to believe that the worst is over and the time is ripe to buy again.

"As bad as things are, they can still get worse, and get a lot worse," said Bill Strazzullo, chief market strategist for Bell Curve Trading, who said he believes the Dow might fall to 5,000 and the S&P to 500.

The Dow's descent has been breathtaking. It took only 14 trading sessions for the average to fall from above 8,000 to below 7,000. For the year, the Dow has lost 23 percent of its value.

Its last close below 7,000 was May 1, 1997 -- a time when the market was barreling to one record high after another because of the boom in technology stocks, but often suffered big drops as investors worried about inflation and rising interest rates.

This time around, Wall Street analysts seem to believe that a stock market recovery will first require signs of health among financial companies, and on Monday those signs seemed further away than ever.