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Wachovia, Golden West shareholders OK merger

The shareholders have spoken:

Wachovia Corp. and Golden West Financial Corp. easily won shareholder approval on Thursday for their merger, which would combine the fourth-largest U.S. bank with the No. 2 U.S. savings and loan.

The acquisition of Oakland, California-based Golden West would give Wachovia its first significant branch presence on the U.S. West Coast, and significantly expand its mortgage operations. Wachovia is based in Charlotte, North Carolina.

Regulators still must approve the deal.

At separate shareholder meetings, about 93 percent of Wachovia shares cast and 99 percent of Golden West shares cast voted in favor of the merger, representatives for the companies said.

The companies valued the merger at $25.5 billion when they announced it in May and expect it to close in the fourth quarter. Golden West shareholders would receive 1.051 Wachovia shares and $18.65 in cash for each of their shares.

Posted by edelfenbein at 4:25 PM

Random Thoughts

I hope things are as quiet where you are as they are here on the 81st floor of the Crossing Wall Street Tower.

Here are a few completely random thoughts for this morning. Do you realize that 2006 is already two-thirds over? That means this decade is also two-thirds over. Scary! We’re entering the late-aughts!

The yield on the 10-year T-bond (^TNX) dipped below 4.75% this morning. Wow. That’s a drop of 50 basis points since June. (Of course, June was way back in the mid-aughts, so that may explain it.)

Yahoo Finance has gone all blinky. Take a look. I think it’s a good thing, except it seems harder to scroll down longer portfolios.

One month ago, Wall Street was expecting a GDP report of 3% growth. It came in at 2.5%, and the S&P jumped 1.2%. Yesterday, the GDP report said “no, you were right the first time—it was 2.9%.” Yesterday, the S&P did nothing. Weird.

The Census Bureau came out with its big yearly report yesterday. You can geek out to the data. Here's something that probably surprises most people, but not me. The median family income for Prince George's County, MD is $74,767. For Orange County, CA, it's $74,396. In other words, the PG is richer than the OC.

Posted by edelfenbein at 11:08 AM

First Industrial Realty

Congratulations to Warren Buffett who not only turned 76 yesterday, but he also got married.

Here’s a quick Buffett story. In late 1999, a man paid $210,000 for a wallet, in what could have been the worst wallet investment in history. There are, however, a few facts I need to add. First, it was for charity. Second, it was Buffett’s old wallet.

Oh…and did I mention the stock tip? I guess that could help explain the price tag. Inside the wallet, Buffett left a stock tip. The stock he recommended was First Industrial Realty (FR).

The wallet buyer graciously made the stock tip public. I don’t have a reference to the exact day, but I think I’m going to go with December 17, 1999. The records show that shares of FR had one their biggest jumps ever on eight times their normal volume. After all, this is a sleepy Real Estate Investment Trust (or REIT).

Now I have to remind you that in late 1999, no one was buying REITs. No one. Tech was king. To add some perspective, Morgan Stanley has a REIT Index (^RMS). In October 1997, the index got over 365. By December 1999, it was down to 265. To reiterate, no one was buying REITs.

REITs aren’t supposed to move a whole lot. They have a special tax advantage, and the trade-off is that they must pay out almost all of their profits as dividends. So while every dot.com was soaring, the high yield stocks weren’t standing still, they were falling. The higher tech went, they lower these stocks fell.

On December 16, 1999, FR closed at $24.39. For the previous 12 months, it had paid four quarterly payments of 60 cents a share. So without even looking at the company, we know it was yielding 9.8%. Plus, the company had just raised its dividend to 62 cents a share, so investors could count on a yield of close to 10.2%.

Not only did FR jump on December 17, but the news of Buffett’s recommendation lifted the entire REIT sector. Who knew that real estate was about to take off?

Yesterday, First Industrial closed at $43.35 a share, so the stock has climbed over 67% from the price after the Buffett news was made public. If you include the very generous dividends, which are now at 70 cents a share, the investment in FR would have made you over 180%. Over the same period, the S&P 500 is down about 8%, although dividends have given the index a slight gain.

If the wallet buyer started with a portfolio of $350,000 (let’s consider the $210,000 an advisory fee—60% would embarrass even a hedge fund manager), and the remaining $140,000 was all put into First Industrial, he would be ahead today.

So maybe it wasn’t the worst wallet investment in history.

Posted by edelfenbein at 10:20 AM

RadioShack Lays Off Employees Via E-Mail

The New Economy kinda resembles the old:

RadioShack Corp. followed through on its announced plans to cut about 400 jobs, but the electronics retailer has been forced on the defensive about its method of notifying laid-off employees by e-mail.

Employees at the Fort Worth headquarters received an e-mail Tuesday morning telling them they were being dismissed immediately.

"The work force reduction notification is currently in progress," the notice stated. "Unfortunately your position is one that has been eliminated."

Posted by edelfenbein at 3:38 PM

Gladwell Vs. Blogosphere

Recently, I linked to a New Yorker article on Dependency Ratios by Malcolm Gladwell, so I feel an obligation to post some of the criticism. First in the fray was the blogger Winterspeak. Gladwell responded. Then Jane Galt jumped in, followed by a (comically) snippy response from Gladwell, and then a Galt rejoinder.

Personally, I don’t think Gladwell comes off well. (Hat tip: DealBreaker.)

Posted by edelfenbein at 12:45 PM

Second-Quarter GDP

Second-quarter GDP growth was revised higher to 2.9% today from the initial estimate of 2.5%. I knew this was going to be a higher revision. I just didn't know how much.

The bottomline is that I don't see this as being a soft landing scenario. At least, not just yet. Let's add some perspective. In the 10 quarters previous to Q2, the economy grew by an average of 3.4% a year. Now we're tossing in a 2.9%-er. That's not a big change. It's still well within the bounds of its previous trend. Three of those 10 quarters had growth less than 2.9%.

Posted by edelfenbein at 8:50 AM

The Buy List So Far

Here's how the Buy List has done this year.

Through yesterday, we're down -0.47% and the S&P 500 is up 4.29%. Only two months ago, we were ahead of the market.

Posted by edelfenbein at 9:44 AM

Tomorrow’s GDP Report

One of my pet peeves is the initial report on GDP. Every three months, the government reports on how well the economy did in the just-ended quarter. The first report comes out at the end of the first month of each quarter (January, April, July and October). It’s then updated twice more, at the end of each succeeding month. Tomorrow, the second-quarter report will be revised.

My complaint is that the later revisions came often be quite large. My feeling is that if that’s the case, just wait until you have a better number. There’s no use feeding us information which can deviate so much. Take your time and get it right.

At the end of July, the government said that the economy grew, in real terms, by 2.5% for the second three months of the year. I thought this was way too low. Before the report came out, I wrote that I would be surprised if GDP came in at less than 3.4%. I still feel that way.

When looking at the markets, it’s important not to be too attached to your current outlook. Keynes said, “When the facts change, I change my mind—what do you do, sir?”
That’s always good to remember. But I have a suspicion that the facts haven’t changed. Perhaps all this “soft landing” talk is a bit early.

Bear in mind that it’s not unusual for the GDP to be adjusted by large amounts. For the first quarter, the government initially said that the economy grew by 4.8%. This was later revised to 5.6%. That’s a big change. What we tolerate in economic stats, we would never sit still for in baseball scores. And even after everything is said and done, the GDP numbers can still be altered. With the last report, the government also adjusted every GDP stat going back to 2003.

I’ll have more tomorrow morning when the latest revision comes out.

Posted by edelfenbein at 9:16 AM

S&P 500 Near Three-Month High

There's nothing so screwed up in the stock market that a bond rally can't fix. The 10-year yield got down to 4.78% on Friday. The S&P 500 is poised for its highest close of the summer. If the market holds up, this will be the highest close since May 11.

Posted by edelfenbein at 2:31 PM

Investors Financial Services

If you had told me at the beginning of the year that SEI Investments (SEIC) would be the top-performing Buy List stock, I would have thought you were some sort of marijuana addict. The company has posted terrific earnings for the past few quarters.

Another stock that's somewhat similar to SEIC is Investors Financial Services (IFIN). Here's the chart:

Posted by edelfenbein at 9:57 AM

Sunday Reads

This is a good day to head to the hammock for a good read. Here are two things you might like.

The New Yorker has a fascinating story by Sylvia Nasar (of Beautiful Mind fame) and David Gruber about Grigory Perelman, a mysterious Russian mathematician and the solution to one of math’s greatest problems.

Also, Natural History has an interesting article on the excavation of a Neolithic settlement in Turkey.

Posted by edelfenbein at 11:31 AM

Cyclicals Are Fading Fast

I probably sound like a broken record (if you remember what records were), but once again, here's the Morgan Stanley Cyclical Index (^CYC) divided by the S&P 500:

The cyclicals have had an amazing run, but these are the stocks that have been hit the most since May. What's interesting is that the peak level earlier this year almost perfectly matches the peak from 12 years ago. And you can see that the low point is a loooong way down.

Posted by edelfenbein at 10:09 AM

Northwest Gives Advice to Laid Off Employees

Northwest Airlines gave its laid off employees some advice on how to save money. One of the tips was to rummage through other people's garbage. I'm not kidding. NPR has the goods.

Here's the full list. Check #46.

Ironically, Northwest is the one that filed for bankruptcy last year.

Posted by edelfenbein at 10:50 AM

Creative Descruction and Pet Supplies

Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary. And this evolutionary character of the capitalist process is not merely due to the fact that economic life goes on in a social and natural environment which changes and by its change alters the data of economic action; this fact is important and these changes (wars, revolutions and so on) often condition industrial change, but they are not its prime movers. Nor is this evolutionary character due to a quasi-automatic increase in population and capital or to the vagaries of monetary systems, of which exactly the same thing holds true. The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers, goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates. – Joseph Schumpeter in Capitalism, Socialism and Democracy

That’s a nice way to lead into two stories I saw this morning. The first is the earnings warning from Chico’s FAS (CHS). The company has been one of the top stocks for the past 10 years. In fact, CHS has beaten the S&P 500 for the past nine straight years. Not this year, however. The stock is down 20% this morning, and over 55% year-to-date.

The other story is from Patterson Companies (PDCO). The company reported a quarterly earnings decline this morning. For the July quarter, the company earned 30 cents a share, one penny less than last year. Bear in mind that Patterson used to churn out 20% EPS increases like clockwork. Seeing them struggle is quite a shock.

Posted by edelfenbein at 10:31 AM

The Dow's Decimals

I was curious to see if there's any strange pattern to the decimals in the daily closings of the Dow. It turns out, there aren't any. At least, not that I could find.

I looked at the daily closings for the past 10,000 trading sessions, which is roughly 40 years. I figured that each "hundredth" (i.e., .01, .02, .03) should have about 100 each.

It looks like they do. Here are the results:

The table goes from left to right, from .00 to .99. Double Zero comes on at 100 even, although .01 has the fewest with 78 days. The most is .13 with 126.

Here's how they break down:

.13.........126
.77.........119
.14.........118
.25.........116
.78.........116
.15.........114
.45.........114
.68.........114
.04.........113
.43.........113
.41.........112
.59.........112
.56.........111
.70.........111
.10.........110
.12.........110
.20.........109
.36.........109
.98.........109
.11.........108
.18.........108
.64.........108
.79.........108
.92.........108
.32.........107
.63.........107
.65.........107
.48.........106
.97.........106
.23.........105
.27.........105
.44.........105
.74.........105
.83.........105
.84.........105
.09.........104
.55.........104
.57.........104
.99.........104
.21.........103
.61.........103
.72.........103
.90.........103
.37.........102
.54.........102
.71.........102
.95.........102
.46.........101
.53.........101
.00.........100
.06.........100
.42.........100
.82.........100
.89.........100
.07.........99
.29.........99
.34.........99
.85.........99
.08.........98
.31.........98
.69.........98
.26.........97
.75.........97
.87.........97
.03.........96
.30.........96
.35.........96
.50.........96
.51.........96
.67.........96
.91.........94
.19.........93
.52.........93
.86.........92
.28.........91
.47.........91
.49.........91
.81.........91
.88.........91
.94.........91
.05.........90
.40.........90
.80.........90
.16.........89
.24.........89
.66.........89
.73.........89
.22.........88
.39.........88
.62.........88
.38.........87
.60.........87
.76.........87
.02.........86
.96.........86
.93.........84
.58.........82
.17.........81
.33.........80
.01.........78

Seven of the top 21 begin with 1, which could be the result of Benford's Law.

And to answer your e-mails: Yes, the plot of Office Space was the inspiration for this post.

Posted by edelfenbein at 11:05 PM

Cisco's Peak

Here’s something you might enjoy.

This link will take you to the Yahoo Message board posts for Cisco’s stock on March 27, 2000. That was the highest day for the hottest stock of the era. These posters are so madly in love with their stock it’s almost funny. Absolutely no criticism is allowed. Just look at the posts. They have a religious intensity to them.

Some background: Cisco’s market cap had just surpassed Microsoft’s and it was the most valuable company in the world. Dear lord, what were they thinking? The NASDAQ Composite actually peaked at 5,000 two weeks earlier, but the most popular index, the NASDAQ 100, kept climbing and peaked on this day.

The stock opened at $81-7/16 (yuck, remember those awful fractions) and climbed to $82 that morning. At 10:58 am is the first reference to a downgrade from David F. Powers at Edward Jones (boy, he was not popular with the board). Powers merely downgraded it to a Hold from a Buy, but that triggered a minor sell-off.

Within 13 months, Cisco’s stock dropped by 84%. In October 2002, it reached its low of $8.12 a share, a staggering 90% drop. Even today, the shares are still 75% below the day of these posts.

To browse through the posts, just click on the “>” thing by the date and time. I apologize for the language and general moronic nature of the posts, but this is exactly what the investing mind is like.

Enjoy.

Posted by edelfenbein at 3:05 PM

Pool Corp.

Here's an interesting stock, Pool Corp. (POOL). As the name suggests, the company provides pool supplies. They recently changed their name from SCP Pool.

The shares seem a little expensive right now, but the company has been a steady grower. Pool recently said it expects to make $1.80 a share this year, which gives them an earnings multiple of 21.

Here are the sales and earnings going back a few years:

Year..............Sales..............EPS
1996............$235.84............$0.09
1997............$335.02............$0.14
1998............$457.60............$0.23
1999............$572.54............$0.36
2000............$672.27............$0.47
2001............$854.23............$0.59
2002............$983.25............$0.72
2003............$1,155.83..........$0.91
2004............$1,310.85..........$1.19
2005............$1,552.66..........$1.50

The stock is off about 20% from this spring's high. Here's the long-term chart:

Posted by edelfenbein at 1:26 PM

Dow Oil & Gas Index

I'm not one for technical analysis, but I thought this chart was interesting. Since April, the Dow Jones Oil & Gas (^DJUSEN) Index has tried four times to break 500, and it's failed each time. It looks like we may soon see a fifth.

Posted by edelfenbein at 11:33 AM

Medtronic's Earnings

Three weeks ago, Medtronic (MDT) spooked Wall Street by saying that earnings will come in lower than expected. The company gave a range of 53 cents to 55 cents a share. The Street had been expecting 57 cents. After the bell, MDT reported earnings of 55 cents a share so it wasn’t as bad as it could have been.

Last October, the company raised guidance for 2006, 2007 and 2008. I was pretty impressed by that. Medtronic is no slouch. The company has raised its dividend for 28 straight years. Now the company is backing off its 2007 and 2008 calls. Medtronic sees 2007’s earnings coming in at $2.30 to $2.38, and $2.65 to $2.75 for 2008.

Based on those numbers, that makes the stock look pretty expensive.

Posted by edelfenbein at 11:23 AM

What Do Ireland and GM Have in Common?

In the New Yorker, Malcolm Gladwell looks at the dependency ratio, how many people are supported by your current work force. It works for companies and countries:

A second common assumption is that fading industrial giants like G.M. and Bethlehem are victims of their own managerial incompetence. In various ways, they undoubtedly are. But, with respect to the staggering burden of benefit obligations, what got them in trouble isn’t what they did wrong; it is what they did right. They got in trouble in the nineteen-nineties because they were around in the nineteen-fifties—and survived to pay for the retirement of the workers they hired forty years ago. They got in trouble because they innovated, and became more efficient in their use of labor.

Posted by edelfenbein at 9:31 AM

Is Google Following Oil?

I'm not sure, but you can judge for yourself. Here's the Oil ETF (USO) against Google (GOOG) since May:

Posted by edelfenbein at 5:01 PM

Expeditors 8-K Gets a Bad Review

Every few months, the folks at Expeditors International (EXPD) answer investor questions in their 8-K report. It's a great company but their answers sound like they're written by bratty seventh graders.

Soooo...one analyst took it upon himself to edit the Q&A session and send it back to the company. Expeditors was not amused:

21. I have been a hands-on securities analyst on Wall Street since 1962 [44 years]. During that time, I have read many thousands of different Management Descriptions & Analysis in 10Ks and elsewhere. I must say that I am otherwise quite impressed with your management’s performance, and am considering investing in Expeditors. But —granted that some of the selected inquiries that you invited were not especially sophisticated or relevant — as a new reader of Expeditors’ CEO & CFO’s responses to investor questions I find your management’s tone to be astonishingly smug and condescending, and I find your wise-cracking style unnecessary and un-professional and insulting to me, an interested investor. Attached is my copy of your May 23 rd 8K, which I cleaned up to make it more focused and less disrespectful to those investors you invited to query management. If I had been one of the inquirers and read your wise-ass response to me, I would be quite offended. Contemplate cleaning up the inappropriate standup comedy act: it ain’t funny!

===========================================
Thank you for your sincere interest in investing in Expeditors. Your opinion has been duly noted. Needless to say, this does not mean that we completely agree with your opinion, but it has been noted.

The fact that you could be sufficiently exercised about our 8-K’s to actually rewrite portions of a recent effort in order to make them less smug and more respectful struck us as unusual. Most people, when confronted with content that they find offensive or juvenile, simply change the channel or walk out of the theatre. We have to assume that some percentage of our readers have done just that. By taking your time to rewrite our 8-K as you see fit, you have joined that minority that would shout back at the screen rather than quietly moving on.

Fair enough, but then you sent your effort to us - in effect inviting us to share what otherwise would have been your personal problem. This probably was an error on your part. Why share your opinion with those you consider to be unprofessional? Didn’t you consider the likelihood that your efforts would result in a wise cracking response? (Um...didn’t you consider the likelihood that he's an investor, and perhaps he's trying to help you? What do you say to a friend who insists on embarrassing himself? - Eddy)

Truth is that we have never set out to be like the many thousands of other companies out there. While some of the questions we get may not meet your idea of sophistication, the point of our efforts on Form 8-K have been to answer real questions from an inside perspective and to communicate this information to every interested party simultaneously. Our goal has always been to give insight into how this real business is running, not produce sterile and sophisticated boilerplate.

If you don’t like what we have written, and certainly some do not, then don’t bother to read it. If you are really worked up, please stop thinking about investing in our stock. We’ve never hyped our stock and we are not planning to change how we communicate with the investment community anytime soon.

So much for the high road. Since you included a web address with your critique, we took the time to take a look. As you know, you have a page which is entitled “Experience & Credentials” and the last paragraph of this page currently reads as follows:

Thereafter, Xxxxx went on a self-directed sabbatical to modernize his investment theory and to sharpen his investment portfolio skills, and went to Baruch to broaden his knowledge of Individual Taxes; Estates & Trusts; Insurance; IRAs and 529s; and Retirement concerns, such as Social Security and Medicare. Xxxxx continues this learning process, and spends each morning updating himself with events and information: thinking through events that might impact strategic investment decision-making. Xxxxx is a member of the CFA Institute and of the XX and National Financial Planners Assns. Thus, he seeks to continuously deepen and broaden his knowledge, in order to more effectively serve as financial planner, as well as Investment Advisor — a role in which he has long experience.

God damn, these guys are morons! They use x's to preserve his anonymity, but include large sections of his Web site. It took Google, literally, 0.10 second to spit up the result. All for an unfunny joke against a guy who has a valid point, which this idiocy confirms. - Eddy

If we were going to rewrite this paragraph for you, we would probably change it to read as follows:

Following the acquisition of his employer, Xxxxx continued his professional education by attending Baruch. Xxxxx continues this learning process by reading the newspaper each morning and thinking about current events and making money. Xxxxx is a member of the CFA Institute and the XX and National Financial Planners Associations. Xxxxx is a financial planner and investment advisor.

Our version is simpler than yours and yet still conveys all of the essential information. You may not agree with the part about reading newspaper each day, but stripped of the sophisticated puffery, that is literally what your version says about your mornings. If you also watch Fox News, we would add that tidbit as well. We certainly have no intention of offending you.

Yup. That'll show him.

Posted by edelfenbein at 2:48 PM

Rising Oil Prices

The real reasons from The Onion:

Increased demand from oil collectors

More people starting to realize how delicious it tastes

Lack of dinosaurs dying en masse

Paris Hilton seen at red-carpet gala wearing nothing but crude petroleum

Urban children opening oil hydrants to cool down

Wife keeps driving to Kroger’s every day for some goddamn thing

Oil paintings sold in Holiday Inn Express lobbies finally earning respect of art world

Worldwide barrel shortage

Posted by edelfenbein at 11:43 AM

Wachovia Raises Dividend

I haven't talked much about Golden West Financial (GDW) since the merger announcement with Wachovia (WB). It's sort of a dull company and doesn't generate much excitement.

At the end of this month, GDW shareholders will vote to approve the merger. Most of the criticism has come from WB shareholders who think the deal is worth too much. That stock has dropped about 6% since the deal was announced. Assuming all goes well, our GDW shares will soon be exchanged for 1.051 shares of WB, plus $18.65 in cash.

For track record purposes, I'll assume that all the cash was invested in Wachovia stock. Today, Wachovia announced a 10% increase to its quarterly dividend, from 51 cents a share to 56 cents a share.

Posted by edelfenbein at 11:02 AM

The Long Tail

Here's an interesting interview with Chris Anderson, the author of The Long Tail.

Posted by edelfenbein at 10:54 AM

One Wall Street Inc.

I know this is cynical, but as soon as I read the beginning of this WSJ story, I knew where it was going:

The SEC complaint, filed yesterday in U.S. District Court for the Eastern District of New York, accused One Wall Street Inc. and its chief executive, among others, of selling securities to at least 64 investors, falsely promising that the company would soon conduct an initial public offering and that it was preparing to merge with E*Trade Financial Corp.

You know it's coming.

Instead, the SEC said, Chief Executive Donte Jarvis used the proceeds as "a personal piggy bank,"

Not yet.

paying for jewelry,

Almost.

gambling

A little more.

and "adult entertainment" services.

Bingo!

The 31-year-old also was accused of giving his wife, La Shondra Hatter, at least $166,000 in checks drawn on the One Wall Street account. One Wall Street allegedly raised money by issuing unregistered securities starting in March 2003.

This further confirms the "Elfenbein Hypothesis," which states that the securities and porn industry are slowly converging.

Posted by edelfenbein at 10:09 AM

David Phillips on Biomet

David Phillips at 10-Q Detective looks at Biomet (BMET), one of our Buy List stocks:

Biomet is in the midst of several major product launches and management anticipates that the Company will continue to be rolling out instruments at least early into fiscal 2007.

Looking ahead, Biomet said it remains "comfortable" with analysts' sales and earnings estimates of $513 million to $530 million and 43 cents to 45 cents per share for the first quarter of fiscal 2007, and $2.15 billion to $2.22 billion and $1.85 to $1.95 per share for fiscal 2007.

The Company’s valuation looks attractive. The Common Stock’s valuations are priced at multi-year lows. For example, BMET’s P/E is only 17.5 times forward May 2007 consensus estimates of $1.87 per share [low end]. This is a 38.5% discount to its trailing five-year mean multiple of 28.5 times earnings. And with an estimated forward five-year EPS growth rate of 15.0%, the Company’s PEG multiple is an attractive 1.2 times [in line with its peer group multiple, which includes Stryker Corp., Zimmer Holdings, and Smith & Nephew].

Value investors might also note the predictable 30% operating margins, and the 20.4% return on capital (compared to its cost of capital of 5.8%).

Tempering these valuations, however, is the boring—in your face—thesis that there are few catalysts on the event horizon to expand valuation multiples (such as a turnaround in its EBI operations or margin improvement gains).

Patient investors with a longer-term view might consider the current price as an entry point, but (with a dividend yield of 0.90%) we prefer to put our dollars to work elsewhere.

In April 2006, the Company confirmed that it hired investment banker Morgan Stanley to help explore future strategies, including a possible move to put itself up for sale. Analysts have cited Medtronic and Smith & Nephew as potential buyers. The asking price for Biomet, should it decide to sell, could be more than $10 billion—or approximately $44.40 per share.

Posted by edelfenbein at 9:46 AM

Andy Young and Wal-Mart

Many of Wal-Mart's (WMT) critics overlook the fact that the company's shares haven't done particularly well over the past few years. Since the beginning of 2003, the stock is down 10% while the S&P 500 is up over 40%. Of course, that may please some of critics.

The company has embarked on a much-needed PR compaign. As I said before, this may be the world's first PR campaign that itself needs a PR campaign. Now Andrew Young has defended the company due to its bigotry:

Young was asked whether he was concerned Wal-Mart causes smaller, mom-and-pop stores to close. "Well, I think they should; they ran the `mom and pop' stores out of my neighborhood...But you see, those are the people who have been overcharging us, selling us stale bread and bad meat and wilted vegetables. And they sold out and moved to Florida. I think they've ripped off our communities enough. First it was Jews, then it was Koreans and now it's Arabs; very few black people own these stores."

Charming. Young is a former UN ambassador and winner of the Congressional Medal of Freedom. (Hat tip: Ideoblog via DealBreaker).

Posted by edelfenbein at 11:58 AM

To the Beach

That's enough for me. I heading to Newport.

I'll be back Monday. Have a great weekend!

Posted by edelfenbein at 6:56 AM

Dell's Earnings

Dell (DELL) just reported earnings of 22 cents a share, in line with its lowered (um, dramatically lowered) guidance. For last year's second quarter, Dell earned 38 cents a share. Sales were up 4.9%, not much higher than inflation.

The stock was briefly above $23 a share earlier today, but it will certainly open lower tomorrow. The stock may be a little cheap in the near-term, but I really underestimated the problems at Dell. Worst of all, I no longer find management credible. Their reassurances have all come to nothing.

Here's a thorough look at Dell I did when earnings came out last quarter.

Posted by edelfenbein at 4:13 PM

S&P 1300!

One of the unusual characteristics of this market is that stock prices have continued to lag earnings growth. I can’t think of a bull market before when price/earnings ratios have declined as the market wore on.

Thanks to the market getting head-butted in the chest this summer, the market’s price/earnings ratio fell to 15, a level it hadn’t seen in over 11 years. Since then, the market has snapped back and the S&P 500 just broke 1,300 for the first time in three months.

Here’s how the S&P 500 and earnings have done since 1990:

The left scale is the for the S&P 500. The right scale is for earnings. I rigged it so when the lines cross, the p/e ratio is exactly 20.

Notice how much higher the blue line is compared with the peak from six years ago. Profits have soared but the index is still much lower. Here's what the market's P/E ratio looks like:

Down, down, down....

What’s interesting is that lower bond yields aren't helping the market’s p/e ratio climb. Normally, lower bond yields allow the market to carry higher earnings multiples. Not this time.

Today, the market’s p/e ratio is about 15.6 (based on trailing operating earnings). That works out to an earnings yield of about 6.4% (1 divided by 15.6). The market’s earnings yield has most often been about 1% to 2% lower than the yield on the 30-year Treasury bond. Now it’s 1.4% higher. (Note: This is slightly different from the Fed model which uses estimated earnings).

Here's how the earnings yield has fared compared with the 30-year Treasury:

The two lines seem to have mirrored each other until a few years ago.

Hey Eddy, I bet you can't scatterplot that.

You guessed wrong my friend:

The horizontal axis is the 30-year Treasury yield. The vertical is the S&P's earnings yield (the inverse of the p/e ratio). Up to about four years ago, the relationship was fairly strong (r^2=0.54). But the relationship has gone kablooey since then.

All the points north of 4.5% and west of 5.5% have come since 2002.

If the market's earnings yield were to match the 30-year yield, the S&P 500 would have to have to be over 28% higher (or long-term yields would have to rise). On top that, earnings are still growing. By my estimate, profits for the S&P 500 should grow in the low double-digits for the rest of this year and 2007.

Posted by edelfenbein at 12:58 PM

Home Depot’s Earnings

I have a few quick comments about Home Depot’s (HD) earnings. For some reason, people think this company is suffering much worse than it really is. (I defended the stock last month).

Home Depot has beaten Wall Street’s expectations for the past few quarters, and the company did it again on Tuesday. HD earned 93 cents a share, a penny better than expectations.

The company said its earnings will come in at the low-end of its guidance, which was 10% to 14%. Last year, HD made $2.72 a share, so the stock is now going for less than 13 times trailing earnings. If the company makes $3 a share this year (a 10.3% increase), then the stock is trading at about 11 times this year’s earnings.

I think investors are highly distrustful of the stock and they were ready to hear awful news. No such luck yet. I’m not a big fan of Bob Nardelli, but HD is a good stock at a good price.

Posted by edelfenbein at 10:40 AM

July CPI +0.4%; Core +0.2%

Both are in line with estimates. Here's how core and headline inflation have performed over the past few years:

Sorry folks, but we're still not out of the inflation-fested woods yet.

The good news is that the year-over-year core rate is still lower than where it was during much of 2001. Over the last 12 months, the core CPI was up 2.69%.

The bond market is happy this morning, and the yield on the 30-year Treasury is now close to 5%. The 30-year briefly dipped below 5% earlier this month, but it didn't hold. This time may be different.

For the record, Bernanke said that the Fed sees core CPI falling to 2.25% to 2.5% this year, and 2% to 2.25% next year. I don't think that's going to happen.

The chain-weighted CPI was flat for July, although that's not a seasonally adjusted number, the data series is too new to see a clear seasonal pattern. For the last 12 months, the chain-weighted CPI was up 2.54%.

The Fed funds rate is now 2.56% above the trailing core CPI rate. That's still pretty low for an expansion. During the 1990s, the economy was growing much faster than it is now, and real interest rates were much higher.

I think Lacker was right, the Fed needs to raise rates again.

Posted by edelfenbein at 8:25 AM

Dell's Battery Recall

I just checked Dell's Web site, and I'm in the clear. My battery isn't one of the exploding ones.

Here's more info from Dell on their battery recall.

Posted by edelfenbein at 1:48 PM

Tame PPI Report

The market is relieved today by a tame report on producer prices. The government's PPI report showed that wholesale inflation rose just 0.1% last month. Economists were expecting a rise of 0.4%. Core wholesale prices fell -0.3%, the first decline since October.

Blomberg surveyed 60 economists, not a single one was expecting a decline in core wholesale prices. The S&P 500 is up slightly over 1%. The NASDAQ 100 is up close to 2%. Bond yields across the board are much lower. The best sector today is tech, and energy is the only sector that's trading lower.

Posted by edelfenbein at 12:07 PM

The Yield Curve's Impact on Stock Prices

The yield curve has a dramatic impact on equity prices. The steeper the yield curve, the better stocks perform.

I looked at the S&P 500 data along with the yields on the 90-day and 10-year Treasuries. Since 1962, the yield curve has been negative (i.e., the 10-year minus the 90-day) for a total of five years. In that time, the market has lost about 37%.

In fact, the S&P 500 is net flat (not including dividends) for all the periods when the yield curve is less than 78 basis points, which is about one-third of the time. The yield curve hasn't been that wide since last November.

Interestingly, the market also does poorly when the yield curve is at its steepest. At 286 basis points, the S&P 500 starts falling. Perhaps the market senses that the yield curve is about to turn around.

If you want to geek out on the data, here's my spreadsheet. I used weekly data, and I compared the S&P's return to the prior week's yield curve.

Posted by edelfenbein at 9:49 AM

Exploding Dells

I recently read Copies in Seconds the brilliant biography of Chester Carlson, the inventor of the Xerox machine. The early machines were, I guess you could say, a tad bit unreliable. Xerox actually sold fire extinguishers along with the copiers for when, not if, the copiers burst into flames.

If there's any one thing to avoid in a product, it's spontaneous combustion. Now Dell is recalling 4.1 million laptops because the batteries also burst into flames.

The batteries were manufactured by Sony Corp. and used in Latitude, Inspiron, and Dell Precision portable PCs sold between April 2004 and July 18, 2006, Jess Blackburn, a spokesman for Round Rock, Texas-based Dell, said yesterday in an interview.

The action follows Dell's slowest sales growth in four years after US consumers complained that the company's discounts are confusing and telephone hold times too long for service.

Dell in May said it will spend $100 million to improve service and product quality to regain market share lost to Hewlett-Packard Co.

"Dell is trying to bolster its image and this is certainly not going to help," said Brent Bracelin, an analyst at Pacific Crest Securities in Portland, Ore., who rates the shares "sector perform" and doesn't own them. "Another recall is yet another setback for the company that is struggling to regain share in the market."

Posted by edelfenbein at 9:20 AM

Sysco Misses By a Penny a Share

From the AP:

Sysco Corp., the largest foodservice distributor in North America, said Monday its fiscal fourth-quarter profit dropped 11 percent, hurt in part by higher fuel costs and pension expenses. Profit for the quarter ended July 1 fell to $254.1 million, or 41 cents per share, compared with a profit of $284.7 million, or 44 cents per share during the same period last year.

Revenue grew 7 percent to $8.51 billion, from $7.98 billion during the year-ago quarter.

Analysts predicted a profit of 42 cents on revenue of $8.63 billion, according to a Thomson Financial poll.

Fuel costs and pension expenses led to an 8 percent increase in total costs and expenses year over year.

For the full fiscal year, Sysco's profit fell 11 percent, to $855.3 million, or $1.36 per share, compared to $961.5 million, or $1.47 per share a year ago. Revenue climbed 8 percent to $32.63 billion, from $30.28 billion last year.

Posted by edelfenbein at 9:54 AM

The Hidden Bull

This came as a surprise to me but the Morgan Stanley Consumer Index (^CMR) is right at an all-time high. Earlier this year, the index took out its 2000 high, and it’s been slowly crawling higher ever since.

Ironically, today’s report on consumer confidence showed that it dropped to a three-month low. According to the AP, “Economists blamed the deterioration in confidence mostly on galloping energy prices and a cooling in the once-hot housing market.”

That may be true, but it’s not showing up in the shares of consumer stocks. Despite Wall Street’s sour mood, it’s important to remember that the market’s troubles since early-May have largely been confined to cyclical stocks (industrials, materials and technology in particular). Transportation stocks, like Expeditors (EXPD), have been especially ugly lately.

We often talk about the stock market as if it’s one big stock that’s traded every day, but there are thousands of stocks in dozens of industries. Difficult markets don’t affect all stocks the same way.

Health care has been a little unusual. Normally, health care moves with the other consumer stocks, but the sector starting dropping in March. The good news, however, is that health care seem to be making up lost ground.

Bed Bath & Beyond (BBBY) is finally showing some life. I try not to be surprised by what I see the market do, but seeing these shares drop below $32 did catch me off guard.

Next week, we’ll have a few more earnings reports from our Buy List stocks. Sysco (SYY) reports on Monday. Home Depot (HD) on Tuesday, and Dell (DELL) on Thursday. Medtronic (MDT) reports the following Tuesday.

Posted by edelfenbein at 9:57 AM

New Ticker for Harley-Davidson: HOG

On August 15, Harley's ticker will change from HDI to HOG.

The new symbol reflects the long-time nickname for the heavyweight motorcycles manufactured by the Milwaukee-based company. The current symbol is HDI.

Harley-Davidson holds trademarks to the term HOG. H.O.G. is also the acronym for the Harley Owners Group. Started by the company in 1983, the Harley Owners Group has more than one million members and is the largest factory-sponsored rider organization in the world.

In March, I listed my 10 favorite stock symbols:

1. (BUD) Anheuser-Busch

2. (WOOF) VCA Antech (veterinary services)

3. (BOOM) Dynamic Materials

4. (FIZ) National Beverage

5. (LVB) Steinway Musical Instruments (in honor of Ludwig Van Beethoven)

6. (ZEUS) Olympic Steel

7. (CHUX) O'Charley's Inc.

8. (TAP) Molson Coors Brewing

9. (BID) Sotheby's Holdings

10. (LENS) Concord Camera

Posted by edelfenbein at 5:17 PM

The Election Cycle Revisited

A few months ago, I wrote about the stock market’s election cycle. This is one of those bits of market trivia that I usually don’t have much faith in. But I have to admit that the evidence is pretty strong that the market follows a four-year cycle.

The indexes seem to have had several major bottoms during mid-term election years (see here). In April, I crunched the data from Ibbotson and Associates to see what the average cycle looks like, and this is what I got:

You can see that the market runs into a wall in the year after an election, and stays flat through most of the mid-term election year. The theory is that the incumbent president tries to make the economy look great for Election Day, and everything goes to hell shortly afterward. This data was based on the market’s total return (dividends included) from 1926 through 2005.

The data I had was monthly, and I wanted to see if I could narrow it down some. I looked at all the daily closings for the Dow Jones from the start of 1929 through this past Tuesday. That’s roughly 19-1/3 election cycles. This is slightly different because it’s just one index and dividends aren’t included, but I do have the benefit of zeroing in on a specific day.

This is the average Dow election cycle looks like:

You can certainly see a similar pattern here. The market hits its low on September 30 of the mid-term year (not too far away!) and peaks on August 3 of the post-election year. In that 14-month period, the market declines an average of 9.4%. The market is up 46.8% over the other 34 months.

What I really found surprising is that the bullish period is very heavily concentrated within the first 12 months.

From September 30 of the mid-term to September 13 of the pre-election year, the Dow is up an average of 31.6%. To put that in perspective, the Dow averages a gain of 33.1% over the entire four-year period. So every four years, 95% of the market’s capital gains is squeezed into a one-year period (on average).

If you’re curious, the market’s best day during the four-year cycle is September 21 of the election year (+1.15%, thank you 1932) and the worst day is October 19 of the pre-election year (-2.04%, thank you 1987). And most importantly, Leap Day is slightly positive (+0.12%).

Posted by edelfenbein at 6:03 AM

Nicholas Financial

For today's edition of "Widdle Biddy Stocks That Ain't No One Never Heard Of," I give you Nicholas Financial (NICK).

Nicholas is a Florida-based company that provides auto loans for used cars, a segment that's often not served by larger lenders. I'm not joking when I say this is a small company, about 200 employees and a market value of $140 million. Citigroup, by comparison, is over 1,500 times larger.

But dude, check out NICK's results:

Year............Sales (mil).........EPS
1997..............$6.21............$0.12
1998..............$7.94............$0.13
1999............$10.42............$0.22
2000............$14.07............$0.34
2001............$17.80............$0.45
2002............$20.22............$0.50
2003............$22.38............$0.54
2004............$25.50............$0.64
2005............$32.83............$0.80
2006............$42.68............$1.01

That grabs my attention. NICK has certainly found a niche for itself. The company recently reported first-quarter results (the fiscal year ends in March). Net income grew 29%. The company earned 29 cents a share compared with 23 cents last year. This brings their trailing four-quarter earnings up to $1.07 a share. That means that the company is going for less than 14 times earnings.

There's not much info on Nicholas, but here's part of article on the company from 2004:

The interest rate Nicholas can charge is dictated by state regulations, and it won't go into a state where it can't get a rate of at least 20 percent.

Generally, Nicholas borrowers don't qualify for traditional sources. The economy has made more people "credit-challenged," but Finkenbrink says that doesn't mean they are bad risks.

"We try to finance people who may have had trouble because of a divorce, medical problems or job loss, as opposed to 'credit criminals,'" he said.

Creating relationships
The company's branch system is key. Branches require overhead, but they put employees in touch with customers.

"Customers like to come into the office," Finkenbrink said. "We create relationships, and employees often will counsel customers."

The result is low delinquency. For the past few years, about 1 percent to 2.5 percent of total loans due at any one time are more than 30 days past due, according to an April 14 research report from Atlanta-based Westminster Securities.

Many larger companies pulled out of the sub-prime auto loan business in the 1990s when they failed to make a lot of money at it, said Will Lyons, Westminster director of equity research.

Currently, GMAC and Ford Motor Credit dominate the industry, and Nicholas has only one-tenth of 1 percent of the market, according to an investors presentation by Nicholas.

"Nicholas takes a personal approach to every loan they do," Lyons said. "It costs a lot of money to do that, and big companies don't want to take that kind of approach."

Here's the chart:

Posted by edelfenbein at 11:30 AM

The Fed Pauses

Seventeen and done...for now. Not a good move in my opinion.

Here's the statement:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Economic growth has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.

Readings on core inflation have been elevated in recent months, and the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Jack Guynn; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Kevin M. Warsh; and Janet L. Yellen. Voting against was Jeffrey M. Lacker, who preferred an increase of 25 basis points in the federal funds rate target at this meeting.

Lacker is the President of the Richmond Fed.

Two other bank presidents, Moskow and Poole, were probably for another rate increase. Since the bank president's rotate turns, those two won't be able to vote until next year.

Can you tell when the announcement came?

Posted by edelfenbein at 2:52 PM

The Fed's Decision

At 2:15 we'll find out what the Fed will do. For the first time in a while, there's actually some drama to a Fed announcement.

According to the latest futures contracts, the market believes there's a 21% chance of a rate hike. Personally, I'm a little baffled. It's seems pretty obvious that the Fed needs to get rates higher. We'll know more this afternoon.

Posted by edelfenbein at 11:04 AM

My Favorite Links

I'm very bad in updating my links page but I finally got around to it. Please check out some of the other stock bloggers.

Some of my favorites include Justin Walters and Paul Hickey over at Ticker Sense, Barry Ritholtz, John, Elizabeth, Joe, Muffie & Co. at DealBreaker, Herb Greenberg, David Phillips at 10-Q Detective and Michelle Leder at Footnoted.

Posted by edelfenbein at 10:18 AM

Hansen Cracks

Hansen Natural (HANS) has been one of the hottest stocks on Wall Street. But yesterday, the shorts finally caught up to the Monster Energy drink maker.

The company's earnings were in line with expectations (28 cents a share) yet the stock fell $10.40 a share, or 25%. Youch! And that doesn't count the $10 a share it lost in the month before yesterday's open. Shares of Hansen were up 332% in 2004, and 330% in 2005. The stock is "only" up 51% so far this year.

I wonder what would have happened if the company missed earnings.

Posted by edelfenbein at 10:03 AM

Why Interest Rates Are So Important

On Tuesday, the Fed will make its big decision on interest rates. If you’re new to investing, the direction of interest rates is extremely important to the stock market.

Stocks love falling rates, but rising rates act like Kryptonite. Consider these numbers:

Since 1960, the yield on the 90-day Treasury bill has risen on 1,201 weeks. If we islotate those weeks, the market has climbed a total of 144% which works out to 3.9% a year. But on the 1,107 weeks when rates have fallen, the market has climbed over 650%. That comes to 10% a year, or 2.5 times better than when rates are rising.

Rates have stayed the same on 121 weeks for a total return of 16.5%, or 6.8% annualized which is almost the exact average of the other two categories.

Short-term rates hit their lowest point on June 19, 2003 at just 0.79%, and have risen ever since. Since then, the S&P 500 is up 28.6% or 8.4% a year.

Posted by edelfenbein at 6:36 AM

Efficient Couch Market Hypothesis

I own Comfy Couch, the single most comfortable couch in the entire world. It’s plush and squishy and fits me juuusst right. Unfortunately, Comfy Couch is also the ugliest couch in the world. I’m serious, this thing is truly hideous.

Well, I felt the time had finally come to depart with Comfy Couch. Comfy Couch, you see, is getting on in years, and she’s just not what she was. (On a side note, I inherited Comfy Couch from Tobin Smith, one of the market mavens on Bulls & Bears.)

So I advertised Comfy Couch on Craig’s List under the “Free Stuff” section (“Ugly Ass Couch, Free!!”). I waited and waited, but no one wanted her. No e-mails, nothing. I even reposted the ad, but still there were no takers.

Soooo…I changed strategy. I posted the ad under the “For Sale” section (Ugly Ass Couch, $30!!).

Sold. That day.

Efficient market, my ass! It’s like economics, but…freaky.

You’re reading this, of course, on my free blog. Ah, irony!

Posted by edelfenbein at 9:32 PM

"Sometimes libertarians deserve to win an argument"

So says the Washington Post in its editorial on hedge fund regulation:

There are three types of argument in favor of regulating hedge funds, and none is persuasive.

The first invokes systemic risk: If a hedge fund collapses, the banks that lent to it may collapse, too, causing a chain reaction through the financial system. This danger is real, but the banks that lend to hedge funds have a strong incentive to manage it by limiting their exposure to hedge funds and by monitoring the risks that the funds take. Since the Long-Term Capital debacle, this is what banks appear to be doing. Regulatory prodding has encouraged the banks to get smarter, though in some cases the rules perversely permit hedge funds to borrow more if they take on extra risk -- an example of how oversight of this complex industry can backfire.

The second argument for regulating hedge funds is that they are havens of insider trading and other sorts of illegal manipulation. It's true that some prominent cases of fraud involve hedge funds, but this isn't surprising given their size. The law already empowers regulators to go after hedge fund managers who commit financial crimes. It's not clear that extra regulations would add much.

The third argument for regulation concerns investor protection. The SEC suggests that by registering and inspecting hedge funds it can reduce the danger that investors will lose money. Some hedge fund managers are happy to accept this line: To reassure anxious clients, some choose to register with the SEC anyway, and they calculate that submitting to mild regulation now may be smarter than waiting until the political storm that would follow the scandalous blowup of a crooked player in their industry. But this is a case of hedge funds and their customers trying to ensure their reputations by gaining a regulatory seal of approval. The regulators should decline to become a security blanket.

Posted by edelfenbein at 11:23 AM

Mixed Market

AP:

Ceradyne 2Q Profit Doubles

MarketWatch:

Ceradyne net nearly triples

Posted by edelfenbein at 11:19 AM

July Unemployment at 4.8%

The jobs report just came out. The unemployment rate for July was 4.8%. The economy created 113,000 new jobs which was below expectations of 135,000. The futures markets are now decidedly against a rate hike next week.

I just dug into the numbers a little bit. The unemployment rate was reported at 4.8%, but it was really 4.755%, so it rounds up to 4.8%. This is small consolation to the unemployed, but the jobless rate is basically the same as it was in April.

Here's the chart:

Nonfarm payrolls were revised higher by small amounts in May and June (8,000 and 11,000 respectively). In the last four months, the economy has created an average of 112,000 new jobs. In the 30 months prior to that, new job growth averaged 167,000. For contract, in the 1990s, new job growth average over 250,000 a month for seven years. Here's what nonfarm jobs have looked like since 2000:

The yield on the 10-year T-Bond is now down to 4.9%.

Posted by edelfenbein at 8:47 AM

Now It's Medtronic's Turn

Shares of Medtronic (MDT) are getting slammed today. The company said that sales for the first quarter came in below expectations. Analysts were looking for sales of $2.98 billion while the company said that sales were $2.9 billion.

Medtronic also said that earnings will range from 53 cents to 55 cents a share. The Street was looking for 57 cents a share.
In May, the company raised 2007 estimates to $2.40 to $2.48 a share.

Earnings are due on August 22.

Posted by edelfenbein at 11:35 AM

My Problem with the Mankiw Method

As a rule of thumb, I try not to get in the habit of pointing out oversights made by Harvard professors. Having said that, I have a minor quibble with Professor Greg Mankiw.

In the interest of full disclosure, Professor Mankiw is the Robert M. Beren Professor of Economics at Harvard, and he’s also the former chairman of the President's Council of Economic Advisors.

Me? I often blog while wearing bunny slippers.

Anywho, Dr. Mankiw developed the “Mankiw Method,” which is a simple back-of-the-envelope equation for determining the appropriate target for the Fed funds rate:

Federal funds rate = 8.5 + 1.4 (Core inflation - Unemployment)

The Mankiw Method certainly has its benefits. It’s easy to follow, and in my opinion, it would have done a better job than the Fed over the past few years.

There is, however, one major problem with the Mankiw Method. According to the equation, inflation’s impact on interest rates is greater than 1.0. I feel this is a big mistake. What it means is that for every 1% increase in inflation, interest rates rise by 1.4%. Consequently, as inflation increases, real interest rates also rise independent of unemployment.

As long as inflation is low, the equation works well. But once inflation starts creeping up, then we start seeing problems. In February 1991, unemployment stood at 6.6% and core inflation reached 5.6%. According to the Mankiw Method, real interest rates should be 1.5%. In July 2004, unemployment was at 5.5% and core inflation was running at 1.8%. Again, the Mankiw Method would recommend a real rate of 1.5%.

To restate my earlier sentence, for everyone 1% increase in inflation, real rates rise by 0.4%. This seems like extra punishment for an economy just for inflation.

The blog, Political Calculations, also has some issues with the Mankiw Method, which the professor addresses.

Posted by edelfenbein at 6:31 AM

The Fed's Next Move

I wanted to help shed some light on the Fed debate Wall Street has been having. The futures market indicates that Wall Street thinks there’s a 30% chance of a rate hike coming next Tuesday. Personally, I’m surprised so many people feel that way. It seems obvious to me that the Fed will raise rates, or at least, they ought to raise rates.

Let’s take a step back and look at what’s happening. Everybody always wants to know what indicator the Fed is watching. Some people think the Fed should watch gold. Others think it’s employment and wages. Still others think it should monetary aggregates.

I think the best variable to watch is real interest rates. By real, I mean the after-inflation return of short-term Treasury bills. Here’s a graph of the real return of 90-day T-Bills going back more than 50 years (12-month rolling period):

Granted, this isn’t a perfect measurement. Monetarists will say that it’s not a cause but an effect of inflation. The biggest problem is that you never know what future inflation will look like. You only find out the real return after the fact. Still, I think it’s the best way to look at the Fed’s policies.

For example, you can see that rates were too low during much of the 1970s. Real rates were negative for nearly eight straight years. In other words, you got paid to borrow money. That’s the problem with inflation. If it isn’t stopped early, it can spiral out of control.

In my opinion, the Fed lowered rates far too much after 9/11. You can see that real rates were negative for over three years. That’s less than the recession of 15 years ago, which was much worse than the fairly shallow recession earlier this decade. I think we’re seeing the effects of the Fed’s easy money in today’s (still modest) inflation.

Ideally, real rates should be at 0% during a recession, and around 3% during an expansion. The most recent report on core CPI showed that inflation increased 2.64% over the last twelve months (that’s through June). I should also point out that the T-Bill rate is about 30 basis points below the Fed funds rate.

I’d like to see the Fed take rates up another 25 basis points, before pausing. I don’t think pausing now would be a huge error, but it’s better done sooner rather than later.

There’s another fact to keep in mind: There’s a lot of new blood at the FOMC. Two governors joined the Fed earlier this year. Plus, there are two other vacancies (Frederic Mishkin has been confirmed by the Senate but he won’t be sworn in until after Labor Day).

This means that there will be only ten voting members at the FOMC meeting. Since the Fed presidents take turns each year (the New York Fed President is a permanent member), this means that a minority of votes on Tuesday will be cast by people who never agreed to the start of the Fed’s rate hikes two years ago.

We often forget that the FOMC is in fact a committee, but I wouldn’t be surprised to see some dissension next week.

Posted by edelfenbein at 4:39 PM

Too Much for Whole Foods

Last December I wrote that Whole Foods Market (WFMI) was overpriced and probably due for a fall. At the time, the stock was at $76 a share (post-split). What happened? Of course, it rallied $78.

But on Wall Street, the true value of a stock will eventually come through. You just need to be patient. Yesterday, Whole Foods’ stock dropped nearly 12%. The stock is now at $51 a share. That’s a pretty nasty fall.

The company actually reported decent earnings but sales came in below expectations. It’s a good company, but the shares still look pricey.

Posted by edelfenbein at 11:59 AM

Expeditors International Is Getting Slammed

The transportation stocks have been getting punished hard lately. Today's victim is our very own Expeditors International (EXPD).

The company reported earnings today of 25 cents a share, which was just a penny below expectations. The stock is currently down $6 a share, or over 13%. Frankly, the stocks strong rally during the first half of the year pushed it into overpriced territory, so some selling was due.

Posted by edelfenbein at 2:55 PM

Happy August

Ticker Sense notes that two-thirds of the total return of this bull market has come on the first day of the month:

It's that time of the month again - the first of the month. During this bull market, the cumulative return of the S&P 500 on the first trading day of each month is 27.04%. This blows away the cumulative return of the rest of the month which is just 13.44%. This means that 67% of the gains since the market lows of October 2002 have come on the first trading day of the month. The last two months have been especially profitable, with June 1st going up 2.05% and July 3rd going up 0.79%.

Posted by edelfenbein at 9:24 AM

GDP Revisions

Here’s something that hasn’t got a lot of attention. Along with last week’s GDP report, the government revised all the GDP numbers going back to 2003.

Here’s what the new GDP figures look like compared with the old ones:

Here's what the old and new quarterly growth numbers look like:

It turns out that the government had overstated economic growth from 2003 to 2005, and slightly understated growth for the last few quarters. This wasn’t a small revision either. Last month’s report of first quarter GDP was $11.316 trillion (these are annualized numbers and adjusted for inflation). The new number is $11.404 trillion. That’s a reduction of nearly 0.8% or almost $90 billion. Even a small reduction is a huge amount when dealing with the U.S. economy.

While the initial GDP report of 2.5% has received a lot of attention, keep in mind that this number will be revised twice more, at the end of August and again at the end of September. These can be large adjustments too. The initial report of first-quarter GDP was 4.8% and it was later raised to 5.6% (and lowered again from 5.64% to 5.58%).

It could turn out that all the concerns of the “weak” second quarter was much ado about nothing. We place a lot of importance on what the Federal Reserve does, but it’s always good to remember that the Fed never has a clear vision of what’s truly happening. The Fed is trying to drive on a highway by only using a a rear-view mirror. And it’s a blurry mirror at that.

Posted by edelfenbein at 9:01 AM

Donaldson Raises Dividend

There are two small items from last week that I wanted to mention. The first is that Donaldson (DCI) raised its dividend from eight to nine cents a share. Although the dividend yield is still very low (about 1.1%), what impresses me is how regularly Donaldson has increased it. The dividend has doubled in the last three years and tripled in the last seven. For the long-term, the company has increased its dividend by an average of 14% a year. That should put the low yield into some perspective.

I also wanted to touch on Respironics’ (RESP) earnings. The company earned 43 cents a share which was very good. That beat expectations by four cents a share. This was also the end of RESP’s fiscal year so in FY 06, Respironics made $1.47 a share. For next year, the company sees earnings coming in between $1.72 a share and $1.77 a share (or 17% to 20% growth). The Street had pegged earnings at $1.63 a share. The stock didn’t react much from the announcement.

Posted by edelfenbein at 8:31 AM