Archive for October, 2006

• Today’s Jobs Report
  Eddy Elfenbein, October 6th, 2006 at 9:25 am

  This morning, the government reported that the unemployment rate fell to 4.6% (or 4.578% to be exact), which is the lowest rate since before 9/11. But the economy only created 51,000 new jobs last month which is less than half what economists were expecting.
  The economic environment continues to be defined as one with surging corporate profits and very meager job growth. Over the last three years, the economy has created an average of 160,000 new jobs a month, which is just barely above the rate of growth of the labor pool. Contrast this with the 1990s when the economy routinely created over 250,000 jobs a month.

• Berkshire Hathaway Breaks $100,000
  Eddy Elfenbein, October 5th, 2006 at 4:04 pm

  
  The stock reached $100 a share on the first day of trading in 1977.

• The Correlation of Stocks and Bonds
  Eddy Elfenbein, October 5th, 2006 at 12:58 pm

  I wanted to follow-up on my previous post about how stocks and bonds have become correlated.
  This is a very important point, and I think it explains much of the recent rally. Here’s at look at how they’ve performed since April 25. For my bond proxy, I’m using the American Century Target Maturity 2025 Fund (BTTRX).
  
  The two asset categories were negatively correlated until the middle of June. Since then, stocks and bonds have moved in tandem.
  A scatter plot will show it better. Here’s the S&P 500 and the BTTRX from April 25 to June 15:
  
  A downward sloping lines mean a negative correlation. The worse bonds did, the better stocks did. This tells us that money went directly out of one asset and into the other. But then, the markets suddenly converged in mid-June. Here’s a scatterplot from June 16 to yesterday:
  
  Except for a few strays, that’s a pretty strong positive correlation. This tells us that money was coming out of hard assets like gold and into paper assets.

• Third-Quarter Earnings Season
  Eddy Elfenbein, October 5th, 2006 at 11:21 am

  Thirteen of our 20 Buy List stocks ended their quarter in September, so we have these earnings announcements to look forward to:
  Company…………………..Ticker…………………Date……………………EPS
  Wachovia…………………….WB……………………16-Oct…………………$1.19
  SEI Investments…………..SEIC …………………18-Oct…………………$0.57
  Danaher………………………DHR …………………19-Oct…………………$0.82
  UnitedHealth Group………UNH…………………..19-Oct………………..$0.76
  Brown & Brown…………….BRO…………………..23-Oct………………..$0.28
  AFLAC………………………….AFL……………………24-Oct………………..$0.72
  Fiserv…………………………..FISV………………….24-Oct………………..$0.62
  Varian Medical Systems….VAR……………………25-Oct………………..$0.53
  Expeditors International…EXPD…………………7-Nov…………………$0.30
  Fair Isaac……………………..FIC………………………TBA………………….$0.57
  Harley-Davidson…………….HOG…………………….TBA………………….$1.10
  Respironics……………………RESP……………………TBA………………….$0.30
  Sysco……………………………SYY……………………..TBA………………….$0.36

• The Campari Family Feud
  Eddy Elfenbein, October 5th, 2006 at 6:43 am

  How’s this for a dysfunctional family:

  Luca Garavoglia, chairman of the Milan-based beverage company, has just been slapped with a court order to pay his sister and fellow shareholder 100 million euros ($127 million) in damages.
  Maddalena Garavoglia had complained in court in 2000 that the company, in which she held a 23% stake, had tried to push her out in the run up to its 2001 stock-market listing. Using a capital increase, she alleged, it tried to pressured her to sell her holdings to investment powerhouse UBS, misleading her about the value of her stake.

  That’s not all. Maddalena’s brother and mother also face criminal charges for allegedly giving her false information.

• Value Versus Growth
  Eddy Elfenbein, October 4th, 2006 at 3:45 pm

  The market is rolling again today. The Dow broke 11850 and the S&P 500 is closing in on 1350. I’ve mentioned before that this is one of few market rallies I can think of where the market’s P/E ratio has declined as the rally has wore on. Not only that, the market”s dividend yield has climbed as well. In other words, as well as stocks are doing, profits and dividends are growing faster.
  There’s something else interesting to note which is probably related. Value stocks have led growth stocks during this rally. Looking at the relative performance of growth versus value is a basic sentiment indicator. Growth tends to cream value during market tops, and vice versa during market bottoms.
  This rally may not be over. Here’s how growth and value have done since March 2003:
  
  Growth has closed the gap some over the last two months.

• Melissa Francis: Child Star
  Eddy Elfenbein, October 4th, 2006 at 2:00 pm

  
  Before she was Melissa Francis, hardass CNBC reporter, she was widdle Missy Francis playing Cassandra Cooper-Ingalls on Little House on the Prairie.
  Unlike most child stars, Missy’s future lay not in porn and blow, but Harvard and basic cable. Not that there’s some similarity.

• Wolverine World Wide’s Earnings
  Eddy Elfenbein, October 4th, 2006 at 9:28 am

  Wolverine World Wide (WWW) is one of those teeny companies I love to follow. Despite its strange name, the stock is up around 200-fold in the last 30-odd years. Still, most people have never heard of it.
  The company makes shoes under various labels like Hush Puppies, Sebago and even Harley-Davidson (HOG), and its stock has been doing very well lately. Shares of WWW are up about 30% for the year.
  Today looks to be another good day for Wolverine as the company announced very good earnings this morning. EPS rose 9.5% to 46 cents a share, two cents more than Wall Street was expecting.
  This is the company’s 17th straight record quarter. Wolverine also raised its forecast for this year to $1.41 to $1.44 a share, and for next year to $1.56 to $1.62 a share.
  Here are the results for the last few years:
  Year…………………………..Sales…………………………..EPS
  1996………………………..$511.03 ……………………….$0.51
  1997………………………..$665.13………………………..$0.64
  1998………………………..$669.33………………………..$0.65
  1999………………………..$701.29………………………..$0.17
  2000………………………..$665.58………………………..$0.52
  2001………………………..$720.07………………………..$0.72
  2002………………………..$827.11………………………..$0.77
  2003………………………..$888.93………………………..$0.85
  2004……………………..$1,061.00………………………..$1.27
  2005………………………..$991.91………………………..$1.09
  2006*………………………$800.15………………………..$1.05
  * First Nine Month

• Erasing Our Losses
  Eddy Elfenbein, October 4th, 2006 at 12:27 am

  The New York Times writes:

  Market historians have noted that stocks can take a long time to recover from periods of great excess. The Dow and the S.&. P., for instance, did not return to their 1929 pre-crash peaks until 1954, long after the Depression and World War II ended.

  That’s true, but it ignores the effect of dividends–which were quite generous back then–and inflation, which in this case was deflation.
  The total return of the stock market in real terms made a new high by 1936, which is surprisingly similar to the period from the March 2000 peak to today. After 1936, the market collapsed again for another five years.

• The Dow Hits a New All-Time
  Eddy Elfenbein, October 3rd, 2006 at 4:50 pm

  11,727.34.
  After 6.75 years, the market has gained 4.36 points. Booyah!
  With the Dow at a new high, Barry Ritholtz noticed that James Glassman was recently on CNBC to discuss his book, Dow 36,000.
  The book has come in for a lot of criticism over the years, and not all of it undeserved. I’ve even noticed that some commentators seem weirdly obsessed with D36K.
  When the book came out, I wrote a review that was going to appear in Barron’s, but got pulled at the last minute. Well…I figure enough time has passed. Here’s my review of Dow 36,000:

  Now that the Dow Jones Industrial Average has soared over 4,500 points since Alan Greenspan warned us of the market’s “irrational exuberance,” a mini-industry has evolved of publishing books that attempt to explain the “new market.” The latest addition to the genre is Dow 36,000 by James K. Glassman and Kevin A. Hassett, both of the American Enterprise Institute. To give you an idea of how crowded the field is becoming, two other books are titled Dow 40,000 and Dow 100,000.
  Unfazed by the Dow’s stunning climb, mega-bulls Glassman and Hassett have developed their own theory as to why the market has risen so much and why it will continue to rise. Their theory isn’t the usual litany one hears from Wall Street bulls (demographics, triumph of capitalism). Instead, their “36,000” theory goes right to the heart of investment analysis by questioning one of its elemental suppositions: namely, the idea that investments in stocks should demand a premium over investments in bonds due to the riskier nature of stocks. This isn’t split hairs they’re taking on.
  Reciting historical data, Glassman and Hassett show that over the long haul, there is no difference between the risks of stocks and Treasury bonds. Therefore, they reason, there should be no risk premium at all. The authors claim that with the risk premium excised from the market, the perfectly reasonable price, or PRP as they call it, for the Dow is 36,000 (more on that later). Mind you, they’re not merely saying the Dow will eventually hit this magic number sometime in the future. Instead, Glassman and Hassett claim that 36,000 is where the Dow ought to be right now. Or more precisely, that’s where the Dow should have been early this year when they started writing the book. Could they be onto something? At the time, the Dow was at 9000.
  The Dow very well may head to 36K, but it will have little to do with Glassman and Hassett’s theory. Their theory is seriously flawed due to major methodological errors.
  First, Glassman and Hassett err in their selection of an appropriate measure of risk for their purpose. The free market prices risk, just like it prices everything else. That price is included in the price of stocks. In order to measure risk, Glassman and Hassett should use a measurement that isolates risk from the price of stocks. They don’t do this. Instead, they compare the standard deviation of stock returns to the standard deviation of risk-free-bond returns. That’s a different animal. Sure enough, with progressively longer holding periods, stock returns’ standard deviations gradually get smaller. Upon realizing that at long term, the standard deviation of stock returns is the same as bond returns’, actually slightly less, Glassman and Hassett conclude that stocks are “no more risky” than Treasury bonds.
  That’s a faulty conclusion. Even if the standard deviations are the same size, it doesn’t say anything about the risk that they’re looking for. The point is, that risk has still never been isolated: It’s inside those returns no matter how long term you go. The variability of risk’s part of all these returns may be diminishing as well. That can happen even if risk stays exactly the same size. With Glassman and Hassett’s method, we have no idea how big the risk inherent in stock ownership is.
  Without all the mumbo-jumbo, think of two houses, identical in every way except one has a great view of the river, the other does not. How much does the river view cost? Easy. Compare the prices of the two homes, and the difference must be the price of the view. The fact that the prices paid may deviate from their own respective averages the same way, speaks nothing as to the price of the view. Glassman and Hassett are saying that since those deviations are the same, the river view is free.
  Running with this assumption, Glassman and Hassett reason that since risk and reward are related, assets with the same risk will have the same return. Therefore, stocks and bonds will have the same returns. For this to happen, they claim, “the Dow should rise by a factor of four.” How do they get four?
  Glassman and Hassett start with the “Old Paradigm” premise that bond returns plus a risk premium equals stock returns. With the risk premium “properly” removed, the yield on Treasuries—meaning their expected return—should be the same as the expected return for stocks. And that’s their dividend yield plus the dividend’s growth rate. So far, so good. Since the sum of these two is now about 1.5% above today’s Treasury yield, the yield on stocks needs to be adjusted downward in order to bring everything into balance. Specifically, it needs to drop from about 2% to 0.5%. With the yield dropping to one-fourth its previous level, stock prices will jump fourfold. Presto. That’s how we get from 9000 to 36000.
  Not exactly. The authors have made another mistake. It’s impossible to have a one-time-only ratcheting down of the market’s dividend yield. The reason is that if long-term stock returns don’t change, as the authors do assume, a lower dividend yield will always create a commensurate increase in the dividend growth rate. As a result, there will always be a new higher dividend whose yield will always be in need of being notched back down. And as a result, the dividend growth rate will increase, and the cycle will continue ad infinitum. The correct conclusion from their model is not a one-time-only fourfold increase in stocks, but one-time-only infinite increase in stocks. This means the authors are actually insufficiently bullish and, moreover, they’ve mistitled their book.
  Fortunately, the second half of the book is the more valuable by far. Once the authors stop making theories, they start making some sense. In this section, the authors discuss how investors can capitalize on the continuing market boom. The authors estimate the market has another three to five years perhaps before 36K is reached. In any case, their strategies are rather conservative: Buy and hold, diversify, don’t trade too much, don’t let market fluctuations rattle you, don’t time the market. All perfectly sound ideas and not specifically dependent on “Dow 36,000.”
  Glassman and Hassett also give the names of stocks and mutual funds they like. There’s nothing wrong with their stocks in the realm of theory, but readers definitely ought to avoid the author’s so-called Perfectly Reasonable Prices, which invite comparison to the famous description of the Holy Roman Empire—not holy, not Roman, not an empire.
  I’m not familiar with Kevin Hassett’s former work, but I’ve always liked James Glassman’s investing articles for The Washington Post. His articles are consistently incisive and informative. This book, however, is nothing of the sort. Dow 36,000 contains egregious errors and fallacious reasoning.
  Still, I do admire their ambition. With this book, Glassman and Hassett challenged a well-entrenched perception of reality. Being that this perception underwrites trillions of dollars, it’s a very, very, very, well-entrenched perception. Glassman and Hassett lost, and they lost badly. Old paradigms die hard, but they do die.