Spreads Continue to Tighten
Posted by Eddy Elfenbein on August 5th, 2009 at 12:08 pm

Want an explanation for the rally? Check out the dramatic widening and closing of the spread between long-term Treasuries and corporates. The gap is still over 300 points and it was often below 200 during 2004 to 2007.

Scientists Crack Two-Envelope Problem
Posted by Eddy Elfenbein on August 5th, 2009 at 10:33 am

Here’s a fascinating story. Two Australian scientists have cracked the legendary two-envelope problem.
Let’s say that there are two envelopes with money in them, one has twice as much as the other. You can open one see how much is there. You now have the option of switching or holding, what do you do?
The CW says it doesn’t matter, you’re just playing the odds so why bother. Well, these two researchers have a way to beat the odds:

The formula relates a particular amount of money (y) found in the first envelope to the probability (P) that you should switch envelopes to gain in the long term.
For example, if you open the first envelope and see $10, the formula might tell you that the probability you should switch envelopes is 0.1 – that is once in every 10 games played.
The formula calculates a smaller probability of switching the larger the original amount (y) is.
Using the previous example, if y is $100, the probably might drop to 0.01, or 1 in every 100 games.
Random strategy
What’s key to this strategy is that the decision when exactly to switch – in which game – must be random, says McDonnell, who studies random processes in telecommunications and the brain.
McDonnell says their solution is different to those that have gone before because of this random element.
“Our solution is to switch randomly,” he says.
“Each time you are offered two envelopes, you observe the amount in one envelope, and then the larger the amount observed, the less likely it is that you should switch, but the choice is still random.”
“The key result is that this kind of random switching leads to a long-run financial gain in comparison with either (i) never switching or (ii) switching randomly in a manner that ignores the observed amount in the opened envelope.”

So is there a stock market connection? You betcha.

In real life, the actual gain will obviously depend on how much money is actually put in the envelopes, says McDonnell.
Abbott says the growth in money seen in the two envelope problem appears to have some similarities to a theory known as “volatility pumping”.
“Volatility pumping is a way of switching between poor investments and yet winning an exponentially increasing amount of money,” he says.
“It suggests the power of changing your portfolio of stocks periodically, buying low and selling high.”

Siegel Responds to Criticisms on Stock Market Data
Posted by Eddy Elfenbein on August 5th, 2009 at 9:57 am

Professor Jeremy Siegel has responded to Jason Zweig’s criticisms of the data he’s used for long-term stock performance.

The problem Zweig highlights is how few stocks comprise the study Siegel relies on. Zweig notes that Siegel ignores 97% of stocks that were trading in that time frame—and most of those stocks he uses were blue chips. All those ignored dud stocks would certainly have lowered the 10% per year number.
Zweig also finds that Siegel raised the average dividend yield from the 1802 to 1870 period from 5% to 6.4%. That’s a huge increase and it alters the long-term results very significantly.

Siegel responds by pointing to research by Bill Goetzmann and Roger Ibbotson. I happen to be familiar with that data and I still think Zweig’s larger point holds.
The research data collected by Goetzmann and Ibbotson is impressive but I see it as only a start. For example, for months between 1815 and 1834, the data set comprises only a handful of stocks. It’s often less than 20 stocks and sometimes less than 10. The dividend series begins in 1825 and some years it includes less than 20 stocks. I don’t think we should rely on research with so little data.
The problem is that the stock market wasn’t close to a market in the sense we regard it. In fact, common stocks were viewed as similar to bonds. The shares would trade around par value and each year you’d find out what the dividend was. The idea of constant capital gains is a 20th century notion.
Siegel writes:

Researchers agree that the biggest source of uncertainty in early stock data is the dividend yield, which was not always reported. As a result, G-I formed two series of dividend yields, one assuming that those stocks for which they could not find dividends had zero dividends (3.77%), and another which uses the dividend yield of those stocks for which they could find dividends (9.27%). They conclude “The true dividend return to a capital-weighted investment in all NYSE stocks is undoubtedly somewhere in between these two extremes.” My dividend yield, which the article claims is unrealistically high, is 6.4%, actually less than the midpoint of their two estimates.

Pointing out those two data sets that are so far apart is precisely the problem. Selecting a number between them doesn’t help. Sure, 5% and 6.4% are within the bookends, but the difference between the two is extreme, especially when compounded over decades. The fact is that Siegel is basing his arguments on very thin data sources.

The Total Track Record
Posted by Eddy Elfenbein on August 4th, 2009 at 8:27 pm

Here’s a look at the complete record of the Buy List for the last three years, seven months and four days. Not including dividends, we’re down 1.43% compared with a loss of 19.44% for the S&P 500. From the market’s peak on October 9, 2007, our Buy List is off by 15.09% while the S&P 500 is down 35.75%.

Cognizant Technology Solutions Delivers Huge Earnings Beat, Guides Higher
Posted by Eddy Elfenbein on August 4th, 2009 at 11:38 am

The Buy List continues to roll. Cognizant Technology Solutions (CTSH) just reported a huge earnings beat, plus it guided higher. For the second quarter, CTSH earned 50 cents a share which is an amazing 13 cents over estimates.
The company now sees Q3 coming in at 44 cents per share, five cents above consensus. For all of 2009, Cognizant expects EPS of $1.80 versus Wall Street’s consensus of $1.54.
These numbers are great. Shares of CTSH have been up by as much as 10% today, and it’s up over 83% for the year. The stock is an excellent buy.

Goldman Sachs Imitates Goodfellas
Posted by Eddy Elfenbein on August 4th, 2009 at 9:41 am

From the NY Post:

Goldman Sachs CEO Lloyd Blankfein has warned his employess to avoid making big-ticket, high-profile purchases as the gold-plated Wall Street firm hunkers down amid a firestorm of public and political anger over outsize bonus payments.
According to sources at the bank, Blankfein has Goldman in particular, should be toned down in light of the billions in bailout money that banks, including Goldman, have gotten from Uncle Sam.
A source within the bank said Blankfein first began calling for an end to the conspicuous consumption late last year, but has stepped up his campaign in recent weeks as the White House has sought to rein in compensation and as the firm has gotten dinged by a pair of high-profile magazine articles.
“This is a sensitive time for us, and [Blankfein] wants to make sure that we’re not being seen living high on the hog,” said one Goldman exec.

(Via: The Stimulist)

Timmy Blows Top
Posted by Eddy Elfenbein on August 4th, 2009 at 9:35 am

This actually makes me think higher of Geithner, though that’s not saying much.

Treasury Secretary Timothy Geithner blasted top U.S. financial regulators in an expletive-laced critique last Friday as frustration grows over the Obama administration’s faltering plan to overhaul U.S. financial regulation, according to people familiar with the meeting.
The proposed regulatory revamp is one of President Barack Obama’s top domestic priorities. But since it was unveiled in June, the plan has been criticized by the financial-services industry, as well as by financial regulators wary of encroachment on their turf.
Mr. Geithner told the regulators Friday that “enough is enough,” said one person familiar with the meeting. Mr. Geithner said regulators had been given a chance to air their concerns, but that it was time to stop, this person said.
Among those gathered in the Treasury conference room were Federal Reserve Chairman Ben Bernanke, Securities and Exchange Commission Chairman Mary Schapiro and Federal Deposit Insurance Corp. Chairman Sheila Bair.
Friday’s roughly hourlong meeting was described as unusual, not only because of Mr. Geithner’s repeated use of obscenities, but because of the aggressive posture he took with officials from federal agencies generally considered independent of the White House. Mr. Geithner reminded attendees that the administration and Congress set policy, not the regulatory agencies.

Man, I’m curious who the source was. The article quotes one guy at Treasury and only for him specifically adds that he declined to comment “on Mr. Geithner’s tone and language.”

Blinky Is on a Privatization Binge
Posted by Eddy Elfenbein on August 3rd, 2009 at 2:04 pm

I guess vote-counting will still be public:

As President Mahmoud Ahmadinejad starts his second term in office, his government announces the privatization of 14 state-owned, giant companies.
In compliance with the implementation of Article 44 of the Iranian constitution, the government has announced the sale of 40 percent of government shares in 14 state-owned companies, including the National Iranian Gas Company, National Petrochemical Company, Iran Air, Iranian Oil Terminals Company, Iranian Tobacco Company, National Iranian Oil Products Distribution Company, and 10 percent of its shares in a number of oil refineries, the official government website Dolat reported.
The decision was taken at a cabinet meeting on July 28 and approved by the president, the website reported on August 2.
The shares were to be sold at the prices listed on the Tehran Stock Market.
The shares are to be transferred to the “Justice Shares” schemes, the creation and distribution of which has been a cornerstone of Ahmadinejad’s economic policy.
According to the Minister of the Economy Shamsoldin Hosseini, some 23 million villagers have received “Justice Shares.”
However, despite promises, workers’ representatives have complained that they have not received any shares as the company responsible for distributing the ‘Justice Shares’ is due to be liquidated at the end of September.
“Workers are still waiting for Justice Shares, as they are among the low-income groups of society, and must be given the priority in the allocation of supporting services,” the Iranian Labor News Agency (ILNA) quoted Ali Akbar Eyvazi, a member of the Tehran Province Forum of Islamic Labor Councils.
During its first term, the Ahmadinejad government privatized hundreds of state companies and promised to accelerate the process during its second term.

The Cyclical Surge Continues
Posted by Eddy Elfenbein on August 3rd, 2009 at 11:01 am

On an historical basis, the relative strength surge in cyclical stocks is stunning:

The S&P 500 Breaks 1,000!
Posted by Eddy Elfenbein on August 3rd, 2009 at 10:34 am

For the first time since November 5 — the day after the election — the S&P 500 is over 1,000.

Also, Nicholas Financial (NICK) has been as high as $7.49 a share, which gives us a triple for the year.