Archive for July, 2009

• The Puzzling Equity Premium Puzzle
  Eddy Elfenbein, July 15th, 2009 at 10:28 am

  David Merkel has some interesting thoughts on the Equity Premium Puzzle.
  My so-far-ignored-by-the-Noble committee idea is that there is and should be an premium for equities, but it shouldn’t be very much. The idea is simple: If you lend a company money, both you and the company implicitly agree that they can do better with it than you. Therefore, their ROE ought to top the interest rate on the loan.
  A bond can’t buy a stock, but a stock can buy a bond. Moreover, a stock can use leverage to buy even more bonds. Therefore the size of the equity premium ought to be related to the size of the yield curve. What exactly the relationship is…well, I haven’t worked that part out yet.

• Stat of the Day
  Eddy Elfenbein, July 14th, 2009 at 3:41 pm

  General Motors, days in bankruptcy = 39
  Jesus, days in wilderness = 40
  (Source: Bloomberg, KJV)

• Daniel Gross: The Recession is Over (Sorta)
  Eddy Elfenbein, July 14th, 2009 at 3:13 pm

  At the new-and-improved Newsweek, Daniel Gross hops on the Dennis Kneale bandwagon and declares the recession over — though he has a far more intelligent and sardonic analysis:

  (T)wo of the best and most objective forecasters, who are not connected to investment banks or to the CNBC noise machine, have recently called the upturn. Macroeconomic Advisers, the St. Louis-based consulting firm that compiles a monthly GDP index, reported to its clients Monday that while second-quarter GDP was tracking at negative 0.1 percent (recession), the third quarter was tracking at 2.4 percent growth.
  The folks at the Economic Cycles Research Institute agree enthusiastically. It’s not because they’ve detected green pea shoots in Central Park. Rather, it’s because we’ve seen the three P’s, says Laskhman Achuthan, managing director at ECRI, which has been studying business cycles for decades and was one of the few outfits to call the last two recessions with any degree of accuracy.
  The economic data that get the most play in the news—unemployment, retail sales—are coincident or lagging indicators and historically have not revealed much about directional changes in the economy. ECRI’s proprietary methodology breaks down indicators into a long-leading index, a weekly leading index, and a short-leading index. “We watch for turning points in the leading indexes to anticipate turning points in the business cycle and the overall economy,” says Achuthan. It’s tough to recognize transitions objectively “because so often our hopes and fears can get in the way.” To prevent exuberance and despair from clouding vision, ECRI looks for the three P’s: a pronounced rise in the leading indicators; one that persists for at least three months; and one that’s pervasive, meaning a majority of indicators are moving in the same direction.
  The long-leading index—which goes back to the 1920s and doesn’t include stock prices but does include measures related to credit, housing, productivity, and profits—hits bottom and starts to climb about six months before a recession ends. The weekly leading index calls directional shifts about three to four months in advance. And the short-leading index, which includes stock prices and jobless claims, is typically the last to turn up.
  All three are now flashing green. According to Achuthan, the long-leading index growth rate has been recovering since November 2008, the weekly leading index has been recovering since last December, and the short-leading index growth rate bottomed in February 2009. In sequence, each turned up, “and by April the three Ps had all been satisfied.” Sure, corporate profits continue to disappoint, and the unemployment rate is climbing. But for ECRI, which navigates by relying exclusively on its instruments, that’s only a part of their picture. They’re the Spocks of the economic forecasting crowd—unemotional, uninvested in anything but the logic of what history and their dashboard tell them. “From our vantage point, every week and every month our call is getting stronger, not weaker, including over the last few weeks,” says Achuthan. “The recession is ending somewhere this summer.” In fact, it may already be over.

  Hmmm…I hope he’s right but hope isn’t a good research tool. The fact is that the economy still faces a number of headwinds, the most crucial is the deleveraging that’s going on. My fear is that we’re in for a prolonged period of sluggish growth.

• Goldmine $achs
  Eddy Elfenbein, July 14th, 2009 at 10:02 am

  
  When J.P. Morgan formed U.S. Steel in 1901, Henry Adams said that he was “apparently trying to swallow the sun.” Now it looks like Goldman Sachs has swallowed the galaxy.
  Goldman’s second-quarter earnings report was staggering. From April through June, Goldman earned $3.44 billion. That works out to $4.93 a share which is head and shoulders above Wall Street’s consensus of $3.53.

  Chief Executive Officer Lloyd Blankfein made Goldman Sachs the highest-paying Wall Street firm in history before last year’s credit freeze led him to convert to a bank, accept government funds and report the first quarterly loss as a public company. This year Goldman Sachs has issued new stock, repaid the U.S. Treasury and reaped fees from selling stocks and bonds.
  “Goldman’s got a sweet spot in here, they were the go-to players,” said Peter Sorrentino, a senior portfolio manager at Huntington Asset Advisors in Cincinnati, which oversees $13.8 billion including Goldman shares, before earnings were released. “For the time being, they’ve got kind of an open playing field all to themselves.”

  The stock is down slightly this morning, but that’s following its big day yesterday.
  

• BusinessWeek Could Be Sold for $1
  Eddy Elfenbein, July 14th, 2009 at 9:54 am

  From the FT:

  McGraw-Hill could reap just $1 from a sale of Business Week, according to people familiar with the 80-year-old financial magazine’s losses.
  The publisher has appointed Evercore, the boutique investment bank, to sell the business after concluding it was non-core, two people familiar with the decision said.
  McGraw-Hill, which owns the Standard & Poor’s rating agency and a large educational publisher, would only say it was “exploring strategic options” for Business Week. Evercore did not return calls.

  (Via: Ritholtz)

• Will Someone PLEASE Pay Attention to Me?
  Eddy Elfenbein, July 14th, 2009 at 12:52 am

• Sorry Folks, the Fed is NOT a Private Bank
  Eddy Elfenbein, July 13th, 2009 at 1:09 pm

  I’m afraid that I don’t know exactly who Spencer Pratt and Heidi Montag are. I gather they’re celebrities of some sort, but perhaps not truly authentic celebrities.
  In any event, what brought them to my attention was Mr. Pratt’s recent commentary on the Federal Reserve on Alex Jones’ InfoWars. Jones is someone I am familiar with; he uses his show to warn Americans of the growing danger posed by the New World Order.
  The NWO is apparently a conspiracy so vast and complex that it actually reaches into the depths of human understanding of reason and logic to cruelly twist all of Mr. Jones’ arguments into errant nonsense.
  If you jump to the eight minute mark you can hear Spencer tell us that the Federal Reserve is a private company just like Federal Express.
  
  This seems to be a popular misconception about the Federal Reserve. Like many things said about the Fed, it’s not true—the Fed is not a private bank. The best way to describe it would be a hybrid quasi public system. Not surprisingly, the end result was part of a political compromise. If my business were run that way, I wouldn’t consider it private.
  The members of the Fed’s board are appointing by the President and are confirmed by Congress. The FOMC, which is the policy committee, is mixed with board members and regional bank presidents.
  The regional reserve banks do issue stock to member banks but it’s very different from owning shares in FedEx. For one, the banks can’t sell or trade the stock. The dividends are set at 6% a year. Everything after that goes to the Treasury. Plus, the banks have to invest 3% of their capital in the Fed.
  Incidentally, FedEx’s CEO is Fred Smith who’s a member of Skull and Bones so perhaps it too is part of the New World Order.
  (HT: LOLfed)

• More Innumeracy from Jeremy Siegel
  Eddy Elfenbein, July 13th, 2009 at 12:06 pm

  In the Wall Street Journal, Jason Zweig criticizes Jeremy Siegel’s use of historical statistics when looking at long-term market returns. Siegel’s book “Stocks for the Long Run,” purports to tell us that stocks have returned 10% a year on average since 1802.
  Well…it might not be that way.
  Before inspecting the details, I’m suspicious of any study that goes back before the 1920s. The capital markets were simply not mature enough to use in such studies.
  The problem Zweig highlights is how few stocks comprise the study Siegel relies on. Zweig notes that Siegel ignores 97% of stocks that were trading in that time frame—and most of those stocks he uses were blue chips. All those ignored dud stocks would certainly have lowered the 10% per year number.
  Zweig also finds that Siegel raised the average dividend yield from the 1802 to 1870 period from 5% to 6.4%. That’s a huge increase and it alters the long-term results very significantly.
  I’m glad to see someone else finally criticizing Siegel’s work, and Stock for the Long Run in particular. I’ve been doing this for a few years. Here’s a post I wrote in 2006 detailing Siegel’s misunderstanding of the concept of standard deviation:

  Jeremy Siegel is a distinguished professor of finance at the Wharton Business School. He’s written many important articles and books on investing and finance (here’s my review of his last book, “The Future for Investors”). However, I’m afraid Dr. Siegel misunderstands a basis mathematical concept.
  This is from his most-recent “The Future For Investors” column:

  Stock returns are composed of the sum of the average real return on safe bonds, such as U.S. government bonds, which has been about 3 percent, plus an extra risk premium that has averaged between 3 percent and 4 percent per year. This risk premium has propelled stocks above other asset classes in investor returns.
  But this premium may be overly generous. Although stocks are indeed much riskier than bonds in the short run, in the long run they are safer. In fact my studies have shown that over periods 20 years or longer, a portfolio of diversified stocks has been more stable in purchasing power than a portfolio of long-term government bonds. As a result, a long-term stock investor gets rewarded for risk that basically only a short-term stock investor endures.

  He says that over periods of 20 years or longer, a diversified portfolio of stocks has been more stable than a portfolio of long-term bonds. The problem is, that’s not what his research indicates.
  In Chapter 2 of his book, “Stocks for the Long Run,” Siegel looks at how stocks and bonds have performed over long periods. His point is that stocks are more volatile than bonds in the short-term, but over time, stocks have a very good track record of beating bonds. That’s a very important point for all investors.
  But then, he makes a critical error. On page 33, he writes:

  As the holding period increases, the dispersion of the average annual return on both stocks and bonds falls, but it falls faster for stocks than bonds. In fact, for a 20-year holding period, the dispersion of stock returns is less than for bonds and bills, and becomes even smaller as the holding period increases.

  His numbers are right, but his conclusion is wrong. By dispersion, he’s referring to standard deviation. If you recall from your high school math, standard deviation measures variation against the mean. What his data shows is that the variation of returns decreases as you have progressively longer holding periods. That’s a tautology. It must happen, but it doesn’t say anything about inherent risk.
  What Siegel says is that the variation of stock returns against the mean of stock returns decreases faster than the variation of bonds returns against the mean of bond returns. (That’s a mouthful!) But at no point are we comparing stocks against bonds. It’s merely stocks against themselves and bonds against themselves. Siegel is using the wrong instrument to make his point.
  Let’s say we have an asset class that has returned, on average, 10% a year for 100 years. The one-year holding periods might be very volatile. However, the two-year and three-year holding periods will become progressively less volatile. But there’s no insight here, the holding periods have to. They’ll eventually zero in on 10% a year.
  Siegel compares the rate at which stocks “zero in” to the rate at which bonds “zero in.” He says that since stocks zero in on their long-term average faster than bonds zero in on theirs, stocks are safer. They may indeed be safer, but his point doesn’t support that conclusion.

  By the way, it’s Siegal’s error here that led to the disastrous book Dow 36,000. Here’s my explanation.

• Best Video Title
  Eddy Elfenbein, July 13th, 2009 at 11:36 am

  I found this at Barry’s joint this morning:
  

  “Precarious State”: Stocks Fairly Valued But “Could Go Down a Lot,” Shiller Says

  
  Or maybe they won’t.

• Wells Fargo Bank Sues Itself
  Eddy Elfenbein, July 11th, 2009 at 11:43 pm

  That’s one way to control for risk:

  You can’t expect a bank that is dumb enough to sue itself to know why it is suing itself.
  Yet I could not resist asking Wells Fargo Bank NA why it filed a civil complaint against itself in a mortgage foreclosure case in Hillsborough County, Fla.
  “Due to state foreclosure laws, lenders are obligated to name and notify subordinate lien holders,” said Wells Fargo spokesman Kevin Waetke.
  Being a taxpayer-subsidized, too-big-to-fail institution, it’s possible that one of the few ways for Wells Fargo & Co. (WFC: 22.91, -0.34, -1.46%) to know what it is doing is to notify itself with a court filing.
  In this particular case, Wells Fargo holds the first and second mortgages on a condominium, according to Sarasota, Fla., attorney Dan McKillop, who represents the condo owner.
  As holder of the first, Wells Fargo is suing all other lien holders, including the holder of the second, which is itself.

  Sounds like a Coen brothers movie.
  (Via Calculated Risk Via Howard.)