Archive for March, 2014

• What Causes Value and Momentum?
  Eddy Elfenbein, March 12th, 2014 at 8:33 am

  Two of the curious anomalies in finance are the value and momentum effects. Simply put, the momentum effect means that the best-performing stocks have a tendency to keep on rallying and outpace the market. The value effect, by contrast, means that stocks with low valuations often outperform the rest of the market.

  What’s odd is that these two effects seem to run counter to each other. The hottest stocks, one would think, would almost always have to be richly valued. Yet there is clearly a disconnect between price and performance. How can this be?

  In the Financial Times, John Authers talks with Paul Woolley, a former fund manager, who thinks he’s threaded the needle. But first, a few nitpicking points. Authers writes:

  Markets are not perfectly efficient. More or less everyone agrees to this in the wake of the financial crisis. And while asset bubbles have recurred from time to time throughout history, bubble production has accelerated sharply.

  So not only are markets inefficient, but they are more inefficient than they used to be. This is despite rapid technological improvement to make markets faster and more liquid. So why are markets inefficient, and what can be done about it?

  I certainly agree that markets aren’t perfectly efficient. Heck, my website is dedicated to the idea that patient investors can beat the market. But I disagree that bubbles have “accelerated sharply.” True bubbles are fairly rare. The tech bubble and the housing bubble were very real, but just because prices fall doesn’t mean that every downtrend is a bubble. I would argue that, market-wide, stocks weren’t excessively valued in 2007. Maybe prices were a little high, but nothing crazy. Furthermore, I don’t see how the supposed proliferation of bubbles means that the market is less efficient. I suspect that the market is actually becoming more efficient, but that’s in a very general sense.

  Back to Mr. Woolley. Authers writes:

  His intuition is as follows. Funds holding an asset suffer poor returns. This leads to outflows, which force them to sell that asset, creating momentum. It will also lead to “comovement.” As assets flow out of a fund, so all the assets it holds will tend to drop in price. This can extend effects across whole sectors. Eventually, this creates the cheapness that subsequently allows the value effect to prosper.

  For an example, look at “value” funds during the tech bubble of the late 1990s. In absolute terms, they kept rising. In relative terms, they performed terribly compared to the booming tech sector, and a great deal of money was pulled from them. This caused value’s underperformance to deepen and also ensured that the value effect, once the inevitable reversal occurred, would be particularly strong.

  After much mathematics, the momentum effect proves overwhelming for a matter of some years. And momentum, divorced from the real-world fundamentals, leads eventually to bubbles and mispricings.

  As I understand this, he’s saying that the value effect eventually becomes the momentum effect. Honestly, that doesn’t seem right, but I concede that it could be so. My hunch is that value and momentum are separate. I think value is mean reversion writ large, while momentum is simple greed.

• Morning News: March 12, 2014
  Eddy Elfenbein, March 12th, 2014 at 7:21 am

  ETF Outflows Biggest in World on Economy

  Losing Crimea Could Sink Ukraine’s Offshore Oil and Gas Hopes

  Europe Makes a Stink About American Cheese Names

  Obama Will Seek Broad Expansion of Overtime Pay

  U.S. Senate Wind-Down Bill Clips Fannie Mae, Freddie Mac Shares

  U.S. is Said to Probe GM Recall

  Airline Industry Profit Forecast Is Cut on Ukraine Crisis

  Mt Gox Gets US Bankruptcy Protection

  Citi Upgrades J.C. Penney, Says It’s a Comeback Story

  Jos. A. Wearhouse Is Almost a Reality

  Prudential Says Asia Helps it Boost 2013 Profits

  Is a PayPal Split Best For eBay?

  ‘Candy Crush’ Maker King Prices IPO at as Much as $24 a Share

  Credit Writedowns: Russia: Economic Vulnerabilities

  Roger Nusbaum: IPOs: Hot Again

  Be sure to follow me on Twitter.

• What Should Investors Expect?
  Eddy Elfenbein, March 11th, 2014 at 4:10 pm

  In the Wall Street Journal, Brett Arends writes about a subject close to my heart: what can investors expect from the stock market.

  The problem is we can only go on past information. Most long-term studies begin the 1920s, and they show that the stock market has returned about 7% per year, once we include dividends and inflation.

  The problem with that is it covers what Henry Luce called the “American Century,” when our way of life of democratic capitalism spread all over the world. I don’t think that’s repeatable. I’m still optimistic for America, mind you, but I don’t think we’ll see quite the triumph of free minds and free markets that we saw in the 20th century.

  The great bull market from 1942 to 1966 was astonishing. I don’t think many investors realize this. It’s not really discussed because, I suppose, the market never truly crashed again. We have to remember how poorly valued stocks were for many years. The real yield for stocks was often much higher than inflation. Arends writes:

  For example, from the 1920s through the early 1990s stock investors collected an average annual return of 4% just from their dividends. Today the figure is less than 2%. Logically we should expect future total returns to be at least two percentage points lower.

  I disagree that lower dividend yields will translate to lower returns. Even putting aside buybacks (which I don’t like), the payout ratio is far lower than it used to be. Companies used to shell out a large percentage of their profits as dividends. Nowadays, it’s far less.

  Back in the 1950s, U.S. stocks traded at an average of about 11 times the previous year’s earnings, according to analysts. In the 1940s and the early 1980s, valuations fell as low as eight times earnings.

  But after 1982 they became sharply revalued upward. Today the S&P 500 trades at about 18 times earnings. To expect the same again is to engage in Bubble Logic—the belief that things will keep going up simply because they have.

  Again, my view is slightly different. The valuations of the 1940s and 1950s were, indeed, very low. But I believe the valuation revolution of the 1960s is still in place. The problem is that low inflation brought earnings multiples back down again in the 1970s, and that appeared to be mean reversion. I don’t believe it’s reasonable to assume that we’ll revert to single-digit multiples, unless there’s high inflation.

  Strip out these one-off gains and inflation, Rob Arnott recently suggested, and investors ought more realistically to expect about 1.5% a year plus dividends—meaning, in the current environment, an annual return of about 3.5% in real terms. That’s a far cry from 10%.

  I think that’s slightly pessimistic. I would say that investors should expect real returns of 5% from common stocks. That’s 2.5% from capital gains and 2.5% from dividends.

• Lowest Spreads in Six Years
  Eddy Elfenbein, March 11th, 2014 at 11:54 am

  In a recent CWS Market Review, I discussed the market’s growing appetite for risk. We can see this effect by looking at the narrowing yield spread between risky bonds and secure bonds. Before, I looked at CCC bonds, but here’s the spread between BB bonds and Treasury bonds. Double B bonds are among the lowest-rated investment grade bonds.

  

  It recently dipped below 2.6% which it hasn’t done since July 2007.

• Retail Rebound
  Eddy Elfenbein, March 11th, 2014 at 11:49 am

  Here’s the best way to see the weather’s effect on the stock market. This is the relative strength of the retail sector. After a terrible start to this year, retail is finally showing some strength.

  

• Four Million Job Openings
  Eddy Elfenbein, March 11th, 2014 at 11:34 am

  The stock market is quiet again today. There’s not really much economic news this week. The JOLTS report, which is Job Openings and Labor Turnover, today said there were four million job openings in the economy. That’s actually the number for January, there’s a little lag in the JOLTS report.

  The S&P 500 has been as high as 1,882.35 this morning, which is a little over one point from Friday’s intra-day high. We have a good shot of reaching another closing high today.

  I was surprised to see Bed Bath & Beyond ($BBBY) behave so well yesterday despite Friday’s profit warning. Perhaps the market is finally looking past the weather-related events. McDonald’s ($MCD) is particularly strong today. The company reported some sluggish sales numbers, but the CFO made some optimistic comments at an investment conference. It’s simply a cheap stock. The eBay/Icahn spat continues. eBay ($EBAY) said they’ve rejected his board nominees. I’m sure we’ll hear more on this.

  Qualcomm ($QCOM) got to a new high today of $77.20. Express Scripts ($ESRX) is also on the new high board today. ESRX is getting very close to $80 per share.

• Morning News: March 11, 2014
  Eddy Elfenbein, March 11th, 2014 at 5:10 am

  China Suggests Full Interest Rate Liberalisation in Two Years

  China to Pilot Five Private Banks

  Bank of Japan Sticks to Easing Plan as Sales-Tax Bump Looms

  Three Years After Fukushima, Japan Still Struggles to Cope

  Manpower Employment Outlook Survey Points to Confidence Around the World

  Virtu Filing Shines Light on Business of High-Frequency Trading

  Colorado’s First Month of Recreational Pot Tax Yields $2 Million

  Despite Rough Winter, Airlines See Strong Profits

  Regulators, GM Under Fire After Deaths

  Sbarro Files Second Bankruptcy as Mall Traffic Dwindles

  EBay Rejects Icahn’s Board Nominees

  McDonald’s Stock Not on Value Menu Amid Weak Sales

  On the Herbalife Fight, Natural-Gas Plays

  Cullen Roche: “Keynesian” Myths and Misunderstandings

  Jeff Carter: Everyone is a Node on a Network

  Be sure to follow me on Twitter.

• Josh on the Easy Money Myth
  Eddy Elfenbein, March 10th, 2014 at 9:31 pm

  Josh Brown destroys the myth that this has been an easy market:

  It’s been one of the hardest environments in market history. Never before have investors’ wounds been so raw. Never before have there been so many voices polluting the popular consciousness with half-baked conspiracy theories and calls for collapse. Never have there been such a dizzying array of investment vehicle options to confuse and confound. Never have the perceived risks been quite as ferocious.

  In the last five years, investors have dealt with a non-functioning congress, a downgrade of the US Treasury, mass unemployment, exploding deficits, record debt, a possible dissolution of Europe and a slow-motion crash in China and the emerging markets – and that’s before we even get into any specifics. And not only have the threats been unprecedented, the amplification of them – thanks to the desperation of the mainstream media for attention coupled with the advent of a whole new chattering class on social media – has been like an orchestra of clanging pots and pans, car alarms and doberman barks, shrieks and howls, thunder and lightning. Every step of the way some motherf*cker’s been screaming about something about to crash, the calamity waiting around the corner, the next shoe to drop.

  Read the whole thing.

• Cognizant Technology Split 2-for-1
  Eddy Elfenbein, March 10th, 2014 at 10:21 am

  This morning, shares of Cognizant Technology Solutions ($CTSH) split 2-for-1. The new buy is $56 per share.

  For track record purposes, I assume our Buy List is a $1 million portfolio that’s equally weighted among our 20 stocks at the start of the year.

  As such, the CTSH position was 495.1476 shares bought at $100.98. The split changes that to 990.2952 shares bought at $50.49 per share.

  I always want to go out of my way to make sure our Buy List is as transparent as possible.

• Morning News: March 10, 2014
  Eddy Elfenbein, March 10th, 2014 at 7:05 am

  Carney Faces Leadership Test as Currency Scandal Snares BOE

  China’s CSI 300 Index Plunges to Five-Year Low on Export Slump

  Crude Oil Sheds Gains After Weak Chinese Data

  China passenger vehicle market rose 18% in February

  EC to Delay Russian South Stream Gas Pipeline Talks

  Spot Gold Extends Losses and Seen Vulnerable if Ukraine Situation Improves

  Tencent-JD.com Partnership Goes Straight For Alibaba’s Throat

  Chiquita Brands International, Inc. And Fyffes Plc To Combine To Create Leading Global Produce Company

  Japan Display Prices IPO at Bottom of Range

  United Rentals to Acquire National Pump

  Comcast Challenging Disney’s Hold on Tourism Trade

  Alleged Bitcoin Millionaire Nakamoto Gets $28,000 Donations

  Hackers Allege Mt. Gox CEO Still Controls ‘Stolen’ Bitcoin

  Joshua Brown: US Healthcare Spending by the Numbers (spoiler alert: it’s not working)

  Jeff Miller: Weighing The Week Ahead: What Is The Risk And Reward For Stocks?

  Be sure to follow me on Twitter.