Archive for October, 2008

• China to the Rescue
  Eddy Elfenbein, October 8th, 2008 at 11:33 am

  Ken Rogoff suggests a plan:

  The Chinese government could offer to lend up to $500bn (from its current stock of $1,800bn) to the US government for the rescue of its financial sector. Its previous assistance – buying US bonds – was indirect and unconditional. Not so in this case.
  China’s loan offer would be direct to the US government to be spent in the current financial crisis. More important, it would come with strings attached. Tied aid, the preferred mode of operation of western donors since the postwar period, would now be embraced by China.
  What would be the nature of the strings – or “conditionality” as the US Treasury, a longtime practitioner of this art, has called it? Conditionality as imposed by the World Bank and International Monetary Fund was underpinned by an ideology that favoured markets and globalisation. But there was also an assumption that either borrowing third world governments did not understand their benefits or the reformers there needed a “spoonful of sugar” to help overcome any internal opposition.
  China would impose two conditions. First, it would declare that the offer of money was conditional on the US government’s adopting a particular approach to rescuing the banks, namely to favour in the next round the use of government money to recapitalise the banks. Europe has been using this approach and evidence suggests it is the most effective way of dealing with large-scale financial crises.
  The US government – like third world governments in the past – has been unable to adopt the most efficient course of action. This stems from an ideological obsession against “socialising” banks or because inducement is necessary to overcome any domestic opposition to it.
  The second condition would relate to “social safety nets”, which had become standard embellishments to World Bank/IMF adjustment programmes. China would stipulate that monies be devoted to cushioning the impact on vulnerable homeowners, so that they would not be forced into forgoing the American dream of home ownership. Chinese conditionality on this front would achieve an outcome that several economists on the left and right have argued for on grounds of fairness, and also to address the fundamental problem in the housing market.
  For China, this offer of help would have three virtues. First, it would be riding to the rescue of a situation partly created by its own policies of undervalued exchange rates, which led to lax global liquidity conditions. Second, its economic interest would be served because successful US efforts at rescuing its financial sector could help avert an economic downturn, protecting China’s exports, its growth engine.
  Perhaps most important, it would seal China’s status as a responsible superpower willing to deploy its economic resources for the sake of protecting the world economy. And if the means for achieving that are by providing the current hegemon with the largest aid package the world has ever seen with a healthy dose of sensible conditionality, well, what could be more statesmanlike than that?

• The S&P 500 Broke 1,000
  Eddy Elfenbein, October 7th, 2008 at 4:00 pm

  For the first time in five years, the S&P 500 closed in three-digit territory. The index closed today at 996.23.

• Phases of the Moon and the Stock Market
  Eddy Elfenbein, October 7th, 2008 at 11:26 am

  
  Some people think it’s merely a coincidence. Those people would include me.

• The Worst Decade Since the Thirties
  Eddy Elfenbein, October 7th, 2008 at 11:11 am

  Bespoke points out that this decade has been one of the worst in history for stock returns:

  Unless we get a major rally to close out the year (15%+), this will only be the third time since 1900 that the Dow Jones posted negative returns in the first nine years of a decade (excluding dividends).

  

• The Bears Nears Its First Birthday
  Eddy Elfenbein, October 7th, 2008 at 11:08 am

  We’re coming up to the one-year anniversary of the market top. The S&P 500 peaked at 1565.15 on October 9, 2007. Going by yesterday’s close, we’ve lost 32.47%. However, those losses have been heavily skewed toward Mondays.
  Here’s the days-of-the-week breakdown:
  Monday -26.65%
  Tuesday +12.57%
  Wednesday -7.33
  Thursday -2.71%
  Friday -9.29%
  It appears that holding over the weekend is to be avoided. In fact, the combined performance of the three middle days of the week is a gain of 1.49%. The market has lost more than one-third on Monday and Friday combined.

• What Equity Premium?
  Eddy Elfenbein, October 6th, 2008 at 2:52 pm

  One of the fundamental tenants of finance is that stocks do better than bonds over the long haul. The difference is known as the equity risk premium. In other words, it’s the amount that investors are paid to take on the extra risk of owning stocks. (Small but important note: the equity risk premium most often refers to the gain stocks have over short-term T-bills, in this article I’m referring to the gain stocks have over long-term government and corporate bonds.)
  The reason for the equity risk premium has puzzled economists for a long time. In fact, Jim Glassman and Kevin Hassett went so far as to say that it shouldn’t exist, and that’s how they got their Dow 36,000 hypothesis. I did some data-crunching today to add in the market’s recent performance and found that there really hasn’t been much of a premium for a long time. So were Glassman and Hassett correct in their theory except the wrote the book 20 years too late?? (Well, no…but I’ll get to that).
  The best source for long-term investment information is Ibbotson Associates, now a part of Morningstar. Each year, Ibbotson releases its yearbook for historical returns of stocks, bonds, bills and inflation going back to 1926. I often refer to their work on this blog.
  From the end of 1968 to the end of 2007, stocks’ advantage over bonds has been quite modest. Over 39 years, stocks have basically doubled both Treasuries and corporates. Doubling in 39 years may sound nice, but it really isn’t that impressive. It works to about 1.85% a year for corporate bonds and 1.89% for government bonds. Given how much more volatile stocks are, I don’t think you’re being paid a lot.
  Since 2008 has been a horrible year for stocks, I was curious how these data sets have changes. I called Ibbotson but unfortunately, they don’t do any mid-year updates. So I want to see if I could find a reasonable estimate. Obviously using different data sources can alter your results, but I was looking for data that’s broadly considered fair.
  For the S&P 500, Ibbotson uses the dividend reinvested S&P 500. For the first three quarters of 2008, that index is down 19.3%. For corporate bonds, they use Citigroup’s Long-Term High-Grade Corporate Bond Index and for the government bond, they use the 6.375 Treasury that matures in August 2027 (I assume they’ll use a 2028 bond for this year). I couldn’t find the stats on either of these that but I called Vanguard to see how some of their index funds were doing.
  The Vanguard Long-Term Investment-Grade (VWESX) fund is down 7.39% this year, and the Vanguard Long-Term U.S. Treasury (VUSTX) is up 6.69% this year. I think both of these funds can serve as proxies (VWESX has a current yield of 6.69%, an average rating of A1 and an average maturity of 22.5 years; VUSTX has a yield of 3.86% and an average maturity of 17.5 years).
  Tacking these numbers onto the data series, that makes the 39.75-year advantage stocks have over corporate bonds just 1.50%, and only 1.10% for government bonds. If we do a little data picking, we can see that long-term Treasury bonds have outperformed stocks since the summer of 1987, and come in just behind stocks since late 1980. Reasonable people can disagree but that certainly sounds like the long-term to me. This means that you could have sat out the entire stock market over the last 28 years, parked your money in long-term T-bonds and done just as well as the stock market, which we know beats the vast majority of fund managers.

• The S&P 500 and Earnings
  Eddy Elfenbein, October 6th, 2008 at 1:25 pm

  At times like this, I urge caution when looking at market statistics, but here’s the S&P 500 (blakc line, left scale) and its earnings (gold line, right scale).
  
  You’ll notice that I’ve scaled the two axises at a ratio of 16-to-1. That means whenever the lines cross, the market’s P/E Ratio is exactly 16.
  The second-quarter earnings are all in, but we’re about to start the third-quarter earnings season, and we won’t know fourth-quarter for a few more months. As a result, the last two points on the earnings line are estimates. While the bump up in earnings line looks promising, we still don’t know what the future holds.
  This could be a great buying opportunity, but as they say, we’ll know more when we’re a little older.

• 60 Minutes on Credit Default Swaps
  Eddy Elfenbein, October 6th, 2008 at 12:51 pm

• The VIX Broke 56
  Eddy Elfenbein, October 6th, 2008 at 12:23 pm

  Wow! The Dow is now off by over 500 points.
  

• Meet the New Boss
  Eddy Elfenbein, October 6th, 2008 at 10:29 am

  Hank Paulson is due to name the person who will run the $700 billion bailout package. According to reports, Neel Kashkari will oversee the program. Take a guess where Mr. Kashkari used to work. I’ll give you a hint: it rhymes with Boldman Hacks.