Author Archive

  • Morning News: September 18, 2012
    , September 18th, 2012 at 6:19 am

    Europe Banks Fail to Cut as Draghi Loans Defer Deleverage

    ECB’s Coene Says Widening Spreads May Force Spain to Ask for Aid

    In Greece, Restlessness Amid a Push for Cuts

    Oil Falls To $113, Extends Slide

    Defining Bernanke’s New Fed Target

    Morgan Stanley Infrastructure Fund Hit By Volcker Rule

    Apple Reaches $700 as IPhone 5 Shatters Sales Record

    Groupon Falls as Expenses Mount Amid Daily-Deal Fatigue

    Lowe’s Pulls $1.8 Billion Bid for Rona

    Lenovo Makes First Software Buy to Expand in Cloud Computing

    US HOT STOCKS: Office Depot, Tesla, Cliffs Natural Resources, AMN Healthcare

    Dole Food Sells Two Businesses To Itochu For $1.7 Billion

    Success of Crowdfunding Puts Pressure on Entrepreneurs

    Edward Harrison: More On Government Tax Coercion Versus Fiat Money Liberty

    Jeff Miller: Weighing the Week Ahead: Higher Hopes for Housing?

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  • The Missing Risk Premium
    , September 17th, 2012 at 11:17 am

    Imagine if there was a well-established scientific principle that was taught in schools, had won Nobel Prizes and was accepted across-the-board by experts, yet it was completely and totally wrong.

    While this may sound far-fetched, this is the basis of Eric Falkenstein’s new book, “The Missing Risk Premium,” and he makes a convincing case.

    Instead of science, Falkenstein looks at economics and argues that the “risk premium,” the reward for investors who shoulder risk, does not exist. This isn’t small potatoes he’s taking on. The risk premium stands front and center in the world of financial economics, and Falkenstein shows us that there’s very little empirical evidence it even exists.

    We’ve long known that stocks have beaten bonds over the long run. So academics attempted a model to explain this fact. Their model says that the reason why stocks have beaten bonds is due to risk. Of course, they’re just slapping the name “risk” on to something better described as “that which we do not know.” It’s like calling a black hole “Cleveland.”

    The model further states that risk can be quantified and the more of it you take, the better you’ll do. So one would expect that stocks with higher risk should do better than stocks with lower risk. But that’s not the case at all. In fact, stocks with the highest risk do the worst, and stocks with the lowest do the best (Falkenstein is a proponent of minimum volatility investing.)

    Just because the measurement of risk explains the gap between stocks and bonds, when applied to individual stocks, it says nothing. Falkenstein goes beyond the world of stocks and looks at several areas where there’s no payoff in taking more risk, or the payoff is actually negative.

    I think the example of horse racing probably explains this best. Researchers have found that betting on the long-shot has had the worst payoff. My guess is that in any given race, the long-shot will draw interest from bettors who simply want to bet on the long-shot, no matter how good the horse really is. Betting and winning on the favorite may offer a higher payout (losing money somewhat slower), but it’s not as much fun at hitting the rare long shot. This is what probably draws many investors to obviously overpriced risky stocks. They simply want to be in the game, and they’re willing to ignore the numbers. The lottery is the same way.

    What caught my attention is that one of the few areas where a risk premium does appear to exist is at the short end of the yield curve. My guess is that what’s happening is that the characteristic of the asset takes on an over-sized image in the mind of investors. As a result, they’ll over pay for a long shot simply because it’s the long shot. Or they’ll overpay for a risk-free asset simply because it’s risk free. This only works at the extreme and going half way won’t get you half the results.

    Some of these concepts Falkenstein covered in his first book, Finding Alpha. This book, however, is much shorter and less technical. Regular readers of his blog (Falkenblog) will also surely recognize many of these arguments.

    One of the most eye-raising aspects of the book is where Falkenstein discusses the many small losses that individual investors suffer between the stock gains they see reported on CNBC, and the returns they get. Investors are constantly dinged by things like bad timing, transactional costs, bid-ask spreads and taxes. Once you throw in variables like survivorship bias, Falkenstein says that the historical databases we have return bare little resemblance to what made its way towards investors’ pockets. This topic alone could serve as a useful book.

    Falkenstein does say, and I’m inclined to agree, that a risk premium exists between stocks and bonds exists but only for the highly-efficient investor. My guess is that the equity risk premium is probably between 1% and 2% which is far less than what’s accepted by many economists.

    Falkstein’s meta-thesis is that investors aren’t greedy; they’re envious. In other words, they don’t simply want the most they can get. They want more than their neighbors. Once you adopt this frame of reference, it undermines the idea that greater wealth can be purchased with greater risk.

    My only criticism of The Missing Risk Premium is that this is a self-published book, and the editing is somewhat sloppy. Also, some language explaining difficult concepts is unnecessarily convoluted. Still, the argument presented is strong and clear and will hopefully convince the world that better returns aren’t paid for with pain.

  • The Stock Market Opens With Week With a Sluggish Start
    , September 17th, 2012 at 9:37 am

    The stock market looks to open flat to lower this morning. Stocks, of course, have had a good run since Ben Bernanke’s move last week. Over the last four trading sessions, the Dow has added 339 points.

    The bond market is, once again, not pleased with Spain. After some squabbling among finance ministers, yields on the 10-year Spanish bond rose to its highest level in four months.

    Bloomberg picks up this cutting quote from Joachim Fels, the chief economist at Morgan Stanley in London: “Experience suggests that just as day gives way to night, improvement gives way to policy complacency, which is then followed by renewed crisis.” That pretty much sums it up.

    The major economic report this morning showed that the Empire State Manufacturing Index fell to its lowest point in three-and-a-half years. As the name suggests, this covers economic activity in the State of New York. The one bright spot in the report is that the outlook for the future improved greatly since August.

    For reasons not immediately clear, Occupy Wall Street has pledged to disrupt the morning commute for many Wall Streeters. Today is the movement’s one year anniversary.

  • Morning News: September 17, 2012
    , September 17th, 2012 at 6:19 am

    European Squabbling on Euro Crisis Solution May Test Rally

    Draghi Euro Humbles Thought Leaders Seeing End of Union

    Indian Rates Held Steady Despite “Big Bang” Reforms

    German Banks’ Funding Boost Drives Global Loan Rebound

    Istanbul Aims to Outshine Dubai With $2.6 Billion Bank Center

    U.S. to File W.T.O. Case Against China Over Cars

    The Crude World of Middle East Oil

    Stocks, More Than Housing, Seen As Initial QE3 Winners

    Probe Focuses On JPMorgan’s Monitoring Of Suspect Transactions

    Buffett Style Fashions Berkshire’s Foreign Deals

    Hennes & Mauritz Sales Miss Estimates After August Heatwave

    Billionaire Arnault’s LVMH Amasses EU4 Billion in Belgium

    1 Year On, Occupy Is In Disarray; Spirit Lives On

    Howard Lindzon: What does a Market TOP Look Like…Not [Friday]!

    Phil Pearlman: Shrinkologicals: Who Is Really Panicking?

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  • The Market’s P/E Ratio Is Lower Now Than It Was Most of the Time from 1991 to 2010
    , September 16th, 2012 at 8:17 am

    One of the paradoxes of this market is that stocks have climbed higher even as earnings estimates have come down. Consider that the S&P 500’s earnings multiple is up nearly 30% since the market’s low nearly one year ago.

    I think part of the reason for the increased valuation is that the economic uncertainty has started to fade. The Federal Reserve’s move last week probably helped clear up some of that uncertainty.

    What’s interesting is that despite the higher valuations, the S&P 500’s Price/Earnings Ratio is still lower now that it was at any point from March 1995 to October 2008. And except for some brief periods, the market’s P/E Ratio is currently lower than it was during the vast majority of the time from 1991 to 2010.

  • Fed Admits Up Until Now U.S. Has Just Been Coasting Off Money From ‘Avatar’
    , September 15th, 2012 at 12:13 pm

    ‘We Spent It All’ Reveals Bernanke

    From The Onion:

    WASHINGTON—Addressing the nation’s finances at a major economic conference Friday, Federal Reserve chairman Ben Bernanke acknowledged that for the past three years the United States has been scraping by on the revenue generated by the 2009 sci-fi blockbuster Avatar. “By circulating $2.8 billion through the economy in gross box-office receipts alone, the cash from Avatar has been the only thing keeping America’s head above water,” said a solemn-faced Bernanke, adding that when money from the theatrical release ran dry, DVD sales had been able to pick up just enough slack to keep the United States solvent for another year. “We had hoped the Avatar money would see us through the end of 2012, but at this point we’ve blown through all the revenue from toys, clothing, video games, and book tie-ins, and it appears we are now headed over the fiscal cliff.” With a sequel not expected until 2015, Bernanke called for an emergency rerelease of the film “in IMAX 3-D with bonus scenes” in order to prevent the United States from defaulting on overseas loans.

  • Seagull Steals Camera
    , September 15th, 2012 at 6:34 am

  • UnitedHealth to Go in the Dow
    , September 14th, 2012 at 12:05 pm

    The keepers of the Dow just announced that UnitedHealth Group ($UNH) will take the place of Kraft Foods ($KFT) in the Dow Jones Industrial Average. These changes aren’t made very often.

    What’s interesting to note is that Kraft has mostly been a market performer but UNH has not. The Dow is going in a different direction and this will increase the volatility of the index.

  • CWS Market Review – September 14, 2012
    , September 14th, 2012 at 8:23 am

    Last week, it was thank you, Mario. This week, it’s thank you, Ben!

    The stock market surged to its highest close in four years on Thursday when it was reported that that the Federal Reserve is embarking on another round of quantitative easing. The last time the S&P 500 was this high was on the final day of trading in 2007. The market had a great day on Thursday, and several of our Buy List stocks like Medtronic ($MDT), DirecTV ($DTV), Hudson City ($HCBK) and Harris Corp. ($HCBK) all broke out to new 52-week highs.

    I’m also pleased to announce that—after many of you requested it—I’ve added a “Buy Below” column to our Buy List page. I think you’ll like it a lot. Now you’ll be able to know exactly what I think is a good entry point for all the stocks on our Buy List. It’s important for investors to stay disciplined and never chase after stocks. My Buy Below prices will help you do exactly that.

    In this week’s CWS Market Review, I’ll explain what the Fed news means, and I’ll try to keep it jargon free. I’ll also discuss what this policy means for the economy and our portfolios. I’ll also highlight upcoming Buy List earnings reports from Oracle ($ORCL) and Bed Bath & Beyond ($BBBY). But first, let’s look at why stocks are so happy with the Bearded One.

    The Federal Reserve Embarks on QE-Infinity

    I have to confess some embarrassment with the Fed’s news, because I had long been a doubter that the central bank would pursue more quantitative easing. I even said last week that this week’s policy meeting would be a snoozer. In fact, I was afraid the market was setting itself up to be disappointed. Instead, the market celebrated the news.

    Now let’s look at what exactly the Federal Reserve did. The central bank said it will buy $40 billion per month of agency mortgage-backed securities (MBS). What will happen is the Fed will swap assets with a bank. The Fed will get a risky MBS while the bank will get low-risk reserves, which, I should add, are held at the Federal Reserve.

    Here’s the problem: Since interest rates are already near 0%, the Fed can’t cut them any further. But the hope is that by buying MBS, the Fed can push down mortgage rates, which will boost the housing market, which in turn will boost the overall economy. At least, that’s the plan. Remember that the housing sector is a key driver of new jobs, and I noted on Thursday that the stocks of many homebuilders gapped up on the news.

    The Fed Changes Course

    The problem with the two earlier rounds of bond purchases is that while they certainly helped the financial markets, their impact on the economy was probably pretty slight. Some critics said that the Fed simply wasn’t being bold enough. What’s interesting is that this round of bond buying is smaller than the previous rounds.

    But here’s the key: The Fed said something very different this time.

    To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

    In other words, this time the Fed’s plan is unlimited. Implicit in the above sentence is the Fed’s admission that its previous policy just wasn’t working. With the earlier bond buying, the Fed just said that they’re going to buy X dollar amount of bonds, and that’s that. There was no goal.

    An idea gaining popularity among economists is that the Fed should buy bonds until some metric like the unemployment rate or nominal GDP hits a specific target. With today’s news, the Fed has clearly moved towards that position without expressly saying so. The Fed said that the bond buying would continue until the labor market improved “substantially” and “for a considerable time after the economic recovery strengthens.” The $40-billion-per-month figure is almost irrelevant in context of an open-ended policy. All told, the Fed will be pumping $85 billion into the economy each month.

    What This All Means

    I may sound overly cynical, but I suspect the Fed will buy bonds until the bond market shuts them off. (Remember when I talked last week about how the Spanish bond market scared the bejesus out of the European Central Bank?)

    The Fed also said that it will keep interest rates near 0% through at least 2015. That’s very good news for a company like Nicholas Financial ($NICK). Another buried angle on today’s news is that the Fed is, in my opinion, giving up on the fiction that it has a dual mandate (low inflation and full employment). When it truly matters, the Fed only cares about employment.

    Will this QE-Infinity work? I honestly can’t say. One fear is that mortgage rates are already low, and that hasn’t done much to boost the economy. Looking at the track of previous quantitative easings doesn’t make me overly optimistic that a third version will do the trick.

    Let’s look at the probable outcomes for the market. I suspect that in the near term, cyclical stocks and financial stocks will get a nice boost. That’s what happened after the first two rounds of bond buying and Operation Twist. JPMorgan Chase ($JPM), for example, soared to $41.40 on Thursday, which effectively erased its entire loss since the London Whale trading loss was announced in May.

    Since the Fed is willing to turn a blind eye toward inflation for the time being, I suspect that hard assets (like gold) and commodity-based stocks will do well. I also think that higher-risk assets will gradually gain favor. For example, spreads between junk bonds and Treasuries will continue to narrow. This will also give a lift to many small-cap stocks, especially small-cap growth stocks. In the long run, I’m not convinced the Fed’s decision this week will have a major impact on the economy. Perhaps the best outcome is that a Fed-induced burst of enthusiasm will give the economy and labor market more time to right themselves. Until then, I urge all investors to own a diversified portfolio of high-quality stocks such as our Buy List.

    Earnings from Oracle and BBBY

    Next week, we have two earnings reports due. Bed Bath & Beyond ($BBBY) reports on Tuesday, September 18, and Oracle ($ORCL) reports the next day. This will be an interesting report for BBBY because three months ago, traders gave the stock a super-atomic wedgie after the company warned Wall Street that their fiscal Q2 would be below expectations. Wall Street had been expecting $1.08 per share, but BBBY said that earnings would range between 97 cents and $1.03 per share. Traders totally freaked and sent shares of BBBY from $74 all the way down to $58.

    For fiscal Q1 (which ended in May), I predicted that BBBY could earn as much as 88 cents per share, which was four cents above Wall Street’s consensus. In fact, the company reported earnings of 89 cents per share. Nevertheless, the weak earnings guidance was too much to overcome.

    In the CWS Market Review from June 22, I said that the selling was “way, way WAY overdone.” Fortunately, I was right. Since bottoming out in late-June, shares of BBBY have steadily rallied. On Thursday, the stock closed above $70 for the first time in three months. BBBY is still a good stock, and business is going well, but let’s be smart here and not chase it. I’m keeping my Buy Below price at $70.

    Oracle has been one of our best stocks this year. The company beat expectations in March and June, although the stock had a terrible month in May. This earnings report will be for their fiscal Q1. The company said that earnings should range between 51 and 55 cents per share, which is almost certainly too low. They earned 48 cents per share for last year’s Q1. Look for an earnings surprise. I’m raising my Buy Below price on Oracle to $35 per share.

    That’s all for now. Don’t forget to check out the new “Buy Below” column on the Buy List page. I’ll have more market analysis for you in the next issue of CWS Market Review!

    – Eddy

  • Morning News: September 14, 2012
    , September 14th, 2012 at 6:35 am

    Bernanke’s Battle for Jobs Eclipses Inflation Concerns

    Asian Shares Rally On Fed Stimulus Measures

    European Stocks Seen Sharply Higher on Fed Boost

    Spain’s Aid Dilemma Takes Center Stage at Euro Crisis Meeting

    Prices Surged for Producers in August

    Gold At Six-Month High As Fed Fans Inflation Risk

    Oil Climbs to Four-Month High on Fed Stimulus Plan

    Fossil Fuel Industry Ads Dominate TV Campaign

    Huawei: Australia Law Could Exclude China Firms

    Home Depot to Shut Seven China Stores, Take $160 Million Charge

    Facebook Outperforming Google in Ad Revenue From Browsing

    Berkshire Posts 25% Intel Gain by Shunning Buy-and-Hold

    A Bump in Path to Wall Street

    Cullen Roche: A Disturbing Look Inside the Mind of Ben Bernanke

    Joshua Brown: The New Rules

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