Archive for 2006

• 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.

• Marvell Warns
  Eddy Elfenbein, October 3rd, 2006 at 9:24 am

  Just seven shopping days until earnings season starts. The traditional first major announcer is Alcoa (AA), which should have outstanding earnings.
  We’re also getting cautionary announcements of what to expect this season. Today’s earnings bomb is brought to you courtesy of Marvell Technology Group (MRVL). The company anticipates that its revenues will fall 10% from last quarter’s total of $574 million.

  The anticipated decline in net revenue is largely due to lower than expected demand from a number of the Company’s hard disk drive customers. The Company believes the shortfall of demand is primarily due to a combination of weaker than normal seasonal shipments in the personal computer market as well as excess inventory held by some of its significant storage customers.

  If that’s not enough, the company is also looking at its options practices.

• Wachovia Closes Golden West Purchase
  Eddy Elfenbein, October 2nd, 2006 at 9:38 am

  It’s official:

  Banking and financial services company Wachovia Corp. said Monday it closed its acquisition of Golden West Financial Corp. and named three new board members, two of them Golden West officials.
  Oakland, Calif.-based Golden West, which operates as World Savings Bank, is one of the largest thrifts in the U.S. Its shareholders will receive 1.051 shares of Wachovia stock and $18.65 cash for each Golden West share they own.
  Of the new board members, Jerry Gitt, 63, and Maryellen Herringer, 62, had been directors of Golden West. Timothy Proctor, 56, is the general counsel of Diageo PLC, a London-based beverage company.
  Herbert and Marion Sandler, the husband-and-wife team who ran Golden West for much of their 45-year marriage, will continue to advise the new management.

  Wachovia (WB) will now appear on the Buy List in place of Golden West Financial. For Buy List tracking purposes, we have to make some changes (someone please double-check my math!).
  At the beginning of the year, we added 757.5758 shares of Golden West at $66 each. With the merger, we now have 796.2122 shares of WB, plus $14,128.79 in cash. Going by Friday’s closing price of $55.80 for WB, that cash is being exchanged for another 253.2041 shares. So now we have a total position of 1049.4163 shares of WB with a cost basis of $47.64554.

• The Housing Bust–Not So Easy Investing
  Eddy Elfenbein, October 2nd, 2006 at 9:22 am

  Henny Sender notes in today’s WSJ that the long-awaited housing bust isn’t developing into a good investing there:

  Playing the housing slowdown in financial markets is proving tougher than anyone expected.
  Some obvious bets against housing haven’t been working out. Even though housing statistics are sinking, home-builder stocks have risen since July and demand for mortgage-backed securities has held up.
  Just last week, the National Association of Realtors made the case for housing bears stronger by reporting that prices of existing homes had fallen for the first time in 11 years.
  The Federal Reserve is working against the bears by pausing its campaign of short-term interest-rate rises.
  If the Fed were to allow interest rates to get too high, that would raise mortgage costs and could tip the economy into a serious slowdown. That is why some investors believe the Fed might cut rates next time it meets. Long-term interest rates already are falling, which is holding down mortgage costs at a critical time.

  New Century Financial (NEW) paid out a dividend of $1.85 a share in September. The company has raised its dividend by a nickel a share for the past several quarters.
  To give you an idea of how negative the market is on housing, if we assume that New Century doesn’t cut its dividend, that means that the stock is indicating a dividend yield of close to 19%, which is the equivalent of 2,200 Dow points.

• Steve Wozniak on CNBC
  Eddy Elfenbein, September 29th, 2006 at 10:56 am

  If you’re getting bored with New High Watch on the Dow, here’s an interesting interview CNBC had with Steve Wozniak this morning.

• No Go for MVNO
  Eddy Elfenbein, September 29th, 2006 at 9:18 am

  I was curious if Mobile ESPN was going to have an impact. Apparently not.

  ESPN is closing down its cell phone company for sports fans after less than a year, planning instead to forge deals in which it provides content to other wireless operators.
  The planned shutdown of Mobile ESPN marks the first major bust in a rush of specialized wireless ventures targeting niche audiences they contend are underserved by the Cingulars and Verizons of the world.
  ESPN was quick to stress that its change in strategy had no bearing on Disney Mobile, another ambitious foray into the cellular market by parent company Walt Disney Co. that was officially launched just recently.
  Disney has so far invested a combined $150 million in developing Mobile ESPN and Disney Mobile, two of the highest-profile and most-heavily marketed efforts to create an “MVNO,” or mobile virtual network operator.
  An MVNO doesn’t have its own wireless network. Instead, it puts its brand on another wireless operator’s service — whose name is hidden from the customer — and offers its own lineup of handsets and calling plans.
  Going forward, Mobile ESPN will cease being an MVNO and instead seek to provide its sports scores, news and video highlights to other wireless companies with large customer bases.

• The Market Reaches All-Time High
  Eddy Elfenbein, September 28th, 2006 at 4:25 pm

  Not the Dow. Not the S&P 500. But the Wilshire 5000 Total Return Index (^DWCT).
  This is the broadest measure of the stock market’s total retun. It includes several thousand stocks, and it’s adjusted for dividends.
  On March 24, 2000, the index closed at 47.84098. Today, it closed at 47.86562.
  For the record, the Dow closed at 11,718.45, which is just 4.53 points below its all-time high close from January 14, 2000. We did, however, peak into record territory during the day.
  The S&P 500 closed at 1,339.15 which is 12.3% below its record close. Adjusting for dividends, it’s down about 2.5%.
  

• The Election Cycle Begins
  Eddy Elfenbein, September 28th, 2006 at 3:01 pm

  
  You only have one shopping day left to take advantage of the four-year Election Cycle. Major caveat: I don’t put much faith in any of this, but here’s what the data says.
  Going back to 1930, the Dow reaches its average bottom on September 30 of the mid-term election year. From that point until September 13 of the pre-election year, the Dow gains an average of 31.6%.
  That means that over 95% of the Dow’s four-year gain comes within the first 12 months of the Election Cycle.
  After that, the market then gets a bit dicey until May 25 of the election, losing 6.6%. But then things start heating up. The market puts on an impressive 19.4% rally to August 2 of the post-election year.
  Then all the troubles start. After August 2 of the post-ection year, the market slides an average of 9.4% until we’re home again–September 30 of the mid-term.

• Danaher Hits All-Time High
  Eddy Elfenbein, September 28th, 2006 at 2:20 pm

  Forget the Dow, look at Danaher (DHR)! After a few days of heavy fighting, the stock finally took out its May high. Shares of DHR are up 23% for us year-to-date.
  From August 9 through yesterday’s close, our Buy List was up 10% compared with 5.6% for the S&P 500.

• Second-Quarter GDP Revised to 2.6%
  Eddy Elfenbein, September 28th, 2006 at 9:10 am

  The initial estimate was for 2.5%, then it was revised up to 2.9%. Now it’s been cut back down to 2.6% growth.