Archive for December, 2007

• Prophet of Innovation: Joseph Schumpeter and Creative Destruction
  Eddy Elfenbein, December 7th, 2007 at 3:35 pm

  
  Brad Delong reviews Thomas K. McCraw’s Prophet of Innovation: Joseph Schumpeter and Creative Destruction:

  Over the previous two and a half centuries, three different economic worldviews, in succession, reigned. In the late 18th and early 19th centuries, Adam Smith’s was the key economic perspective, focusing on domestic and international trade and growth, the division of labor, the power of the market, and the minimal security of property and tolerable administration of justice that were needed to carry a country to prosperity. You could agree or you could disagree with Smith’s conclusions and judgments, but his was the proper topical agenda.
  The second reign was that of David Ricardo and Karl Marx. Their preoccupations dominated the late 19th and early 20th centuries. They worried most about the distribution of income and the laws of the market that made it so unequal. They were uneasy about the extraordinary pace of technological, organizational, and sociological change, and about whether an ungoverned market economy could produce a distribution of income — both relative and absolute — fit for a livable world. Again, you could agree or disagree with their judgments about trade, rent, capitalism, and machinery, but they asked the right questions.
  The third reign was that of John Maynard Keynes. His agenda dominated the middle and late 20th century. Keynes’s theories centered on what economists call Say’s Law — the claim that except in truly exceptional conditions, production inevitably creates the demand to buy what is produced. Say’s Law supposedly guaranteed something like full employment, except in truly exceptional conditions, if the market was allowed to work. Keynes argued that Say’s Law was false in theory, but that the government could, if it acted skillfully, make it true in practice. Agree or disagree with his conclusions, Keynes was in any case right to focus on the central bank and the tax-and-spend government to supplement the market’s somewhat-palsied invisible hand to achieve stable and full employment.
  B ut there ought to have been a fourth reign, for there was a set of themes not sufficiently explored. That missing reign was Schumpeter’s, for he had insights into the nature of markets and growth that escaped other observers. It is in that sense that the late 20th and early 21st centuries in economics ought to have been his: He asked the right questions for our era.

• Looking Behind Today’s Jobs Report
  Eddy Elfenbein, December 7th, 2007 at 10:34 am

  The government reported that unemployment rate in November remained steady at 4.7%. One of the problems about the unemployment rate is that it only measures people looking for a job. If you’re not out there looking, you don’t count. Obviously, the worse the job market is, the more people stop looking for work.
  At the beginning of the decade, around 67% of the population was considered part of the jobs market. Today, that number is closer to 66%. One percent is a big deal in a country this size.
  If the labor market participation rate simply matched the peaked number from February 2000, then it would mean that nearly three million more people would be in the job market.
  Here’s a more accurate picture of employment. This chart shows the number of people working as a percentage of the entire population.
  
  It’s not horrible, but it’s hardly something to brag about either. Clearly, we’re far from our full potential. What I find interesting is the deterioration in the number this year. The good news is that today’s number is a small break in that trend. In November, we saw the largest increase in the percent of the population employed in over five years.

• Nicholas Financial Is Now Trading Below Book Value
  Eddy Elfenbein, December 6th, 2007 at 3:27 pm

  Shares of Nicholas Financial (NICK) are now down to $7.20. According to the most recent 10-Q, the company’s book value is $7.50 a share.

• It Was Only a Matter of Time
  Eddy Elfenbein, December 6th, 2007 at 1:12 pm

  Tired of those socially responsible funds? Well, Focus Shares gives us a sin-based ETF. You guessed it…the Sindex.
  *Groan*
  The ticker symbol is PUF.
  *Double Groan*
  Here are the stocks in the Sindex:
  ABV UN AmBev -PN (ADR)
  AOI Alliance One International Inc.
  ASCA Ameristar Casinos
  BF.B Brown-Forman Corp.
  BTI UA British American Tobacco (ADR)
  BUD Anheuser-Busch
  BYD Boyd Gaming Corp.
  BYI Bally Technologies Inc
  CEDC Central European Distribution
  CG Loews Corp. – Carolina Group
  DEO UN Diageo (ADR)
  HET Harrah’s Entertainment
  IGT International Game Technology
  ISLE Isle of Capris Casinos Inc
  LVS Las Vegas Sands
  MGM MGM Mirage
  MO Altria Group, Inc.
  MPEL Melco PBL Entertainment Macau Ltd.
  PENN Penn National Gaming Inc
  PNK Pinnacle Entertainment
  RAI Reynolds American Inc.
  SGMS Scientific Games
  SHFL Shuffle Master
  STZ Constellation Brands
  TAP Molson Coors Brewing Company
  UST UST Inc.
  UVV Universal Corp.
  VGR Vector Group
  WMS WMS Industries
  WYNN Wynn Resorts Ltd

• High-Yield Defaults Could Quadruple
  Eddy Elfenbein, December 6th, 2007 at 9:34 am

  Here’s a stunning story. Moody’s says that high-yield bond defaults will quadruple next year, and that’s assuming the economy doesn’t go into a recession. If it does fall into a recession, defaults could rise tenfold.

  The global default rate will rise to 4.2 percent by November from 1 percent now, the lowest since 1981, Kenneth Emery, director of corporate default research at Moody’s, wrote in the report e-mailed today. His forecast is based on an assumption the U.S. economy slows without falling into recession. In a recession, defaults may approach 10 percent, he said.
  “We’re certainly looking for an economic slowdown next year and a pick-up in default rates,” said Simon Ballard, macro credit strategist at ABN Amro Asset Management in London. “Any default rate above 3.5 percent would require a very bearish outlook on the U.S. economy.”
  More than one in 10 of the borrowers to which Moody’s assigns ratings are treated as “distressed” by bond traders, the highest proportion since global defaults reached 10.5 percent in 2002. At that time, bondholders charged as much as 11.4 percentage points above government rates to buy high-risk, high-yield debt, double the current average of 5.73 percentage points, according to Merrill Lynch & Co. indexes.

• JOSB Same-Store Sales Up 15%
  Eddy Elfenbein, December 6th, 2007 at 9:12 am

  From MarketWatch:

  JoS. A. Bank Clothiers Inc., (JOSB) the Hampstead, Md., retailer, reported that for November, same-store sales rose 15% while total sales increased 25% to $63.1 million from $50.6 million in the year-earlier month. A survey of analysts by Thomson Financial produced a consensus estimate of same-store sales up 2.2% in the month.

• The Incredible Power of Momentum Stocks
  Eddy Elfenbein, December 6th, 2007 at 8:18 am

  I’m a big fan of Professor Ken French’s data library. I’ve used data from his library at this site many times.
  If you’re not familiar with Dr. French, he’s a well-known finance professor at the Tuck School at Dartmouth. He’s also known for his long-time association with Eugene Fama at the University of Chicago.
  I was digging around some of the files in the library and I was completely stunned by the incredible outperformance of stocks with high momentum, meaning stocks that are surging have a tendency to keep on surging. I was aware of some of the academic literature on this subject, but I have to confess that I was completely dumbfounded by the results.
  I know that stocks with favorable valuation characteristics do better than the rest of the market. For example, stock in the lowest decile (or 10%) of price/earnings ratio have historically beaten the market. The same is true for stocks with higher dividend yields or low price/book ratios. Also, small-caps do better than large-caps (although I’m not particularly impressed by the small-cap premium). These phenomena are very well-known and have been documented countless times.
  But simply put—high momentum creams them all.
  At the data library, French has ten portfolios listed by momentum (see “10 Portfolios Formed on Momentum”). He gets his data from the Center for Research in Security Prices at the University of Chicago. I looked at the long-term returns of stocks with the greatest momentum.
  From the beginning of 1927 through August of 2007, the overall market has returned an average of 10.10% a year. The highest momentum stocks returned an average of 17.76% a year.
  What’s more, that’s just the value-weighted portfolio. By looking at the equal-weighted portfolio, which gives more say to smaller-cap stocks, the results are even more impressive. The equal-weighted high-momentum portfolio returned an average of 21.94% a year. Here’s the chart:
  
  Wow.
  Also, while the momentum portfolios are more volatile, they don’t strike me as being usually high. The monthly standard deviation for the value-weighted momentum stocks is about 20% greater than the rest of the market. The equal-weighted stocks are 37% more volatile.
  The problem I have with many small-cap or value-related models is that the results are highly cyclical. It’s true that small-caps do well after several decades, but it’s not unusual to see underperformance for five years of more. That happened to small-caps in the 1990s and I think value is entering a down phase right now. With momentum, the results are much more consistent. Heck, just look at the red and blue lines.
  There’s also the question of what we mean by stocks with high momentum. I called Dr. French just to make sure I had it right and he was very helpful in explaining it to me. By momentum stocks, he ranks every stock by how it did over an 11-month period, then skips a month and then tracks them for one month. At the end of the month, the whole thing is repeated.
  Confusing?
  He’s an example. On January 1, we take the top 10% of stocks by their performance for the previous January 1 through November 30. The stocks are held for exactly one month and the process is repeated again on February 1.
  This system in completely mechanistic and all emotions are banished. I’ve known lots of people who are momentum investors but they rarely have the discipline to act by strict rules.
  Another interesting aspect of a momentum strategy is the turnover probably isn’t that high. Since it encompasses the best returns for 11 months, many stocks will remain each month. Dr. French said that he thinks the turnover is 91%. That’s high, but not as high as many mutual funds.
  There are lots of historically interesting strategies but many are very impractical. For example, the stock market has been net down on Monday, Tuesday and Thursday combined. But it’s highly impractical to sell all your stocks and buy them a few times each week. But I don’t think that’s the case with a momentum strategy. Also, I’m sure you could even use ETFs to mimic the high-momentum portfolios.
  There’s also the question of why. Why do stocks with high momentum continue to outperform for a bit more? Is there something inefficient in their…frothiness? Can a person really play the height of their frothiness all the time by constantly shifting?
  According to the Efficient Market Hypothesis, this outperformance would rationally be exploited away. I’m not a believer in efficient Market Theory (ironically, it was developed by Eugene Fama) but I do think stocks show a bias towards efficiency. Perhaps there’s something in a surging stock that causes the pre-requisites for an efficient market to break down (flow of information??).
  Dr. French was careful to say that he’s not the discoverer of momentum premium. That award goes to Jegadeesh and Titman who in 1993 found that the best-performing stocks of the last six months outperform the worst over the six to twelve month. I’m very impressed. I’m planning to look into more of the academic literature.

• 2008 Buy List
  Eddy Elfenbein, December 5th, 2007 at 12:39 pm

  I’ll unveil the Buy List for 2008 on Monday, December 17. I’ll start tracking the new stocks on January 1 and use the December 31 close as my buy price. I do this so no one can claim that I have any impact on the shares.
  There are also two more earnings reports before the end of the year. FactSet Research Systems (FDS) reports on December 13 and Jos. A Bank Clothiers (JOSB) reports on December 18.

• Gold and Iran
  Eddy Elfenbein, December 5th, 2007 at 10:41 am

  I’m curious how much the National Intelligence Estimate’s report that Iran suspended its nuclear program four years ago will affect the price of gold. While gold is impacted by inflationary concerns, it’s also influenced by geo-political concerns as well.
  I suspect that problems with Iran have helped boost gold, but I wonder how large the impact has been. When gold is priced in euros, its rise hasn’t been as dramatic, but it’s certainly higher.
  I’m also curious if the surge in support for Ron Paul is a sign of a top for gold. When gold peaked 28 years ago, the Libertarians had their best presidential showing ever. That year, Ed Clark won close to a million votes, including 11.66% in Alaska. The Libertarians even won two statehouse seats in Alaska that year. Double-digit inflation and gold at $850 seem to be very good for the party.
  Since 1980, however, the Libertarian presidential candidates have been lucky to get half what Clark did. Now Ron Paul is running in a perfect environment for Libertarians—gold is up, the dollar is way down. The crucial primary will be in New Hampshire, a state almost tailored-made for them (“Live Free or Die”).
  If Paul breaks 10% in New Hampshire, then I think gold will soon plunge. And no, I’m not serious.

• Headline of the Day
  Eddy Elfenbein, December 4th, 2007 at 3:44 pm

  Countrywide CEO backs Fannie expansion