Banks Keep $35 Billion Markdown Off Income Statements
Posted by Eddy Elfenbein on May 19th, 2008 at 1:23 pm

From Bloomberg:

Banks and securities firms, reeling from record losses resulting from the collapse of the mortgage securities market, are failing to acknowledge in their income statements at least $35 billion of additional writedowns included in their balance sheets, regulatory filings show.
Citigroup Inc. subtracted $2 billion from equity for the declining value of home-loan bonds in its quarterly report to the Securities and Exchange Commission on May 2 without mentioning the deduction in the earnings statement or conference call with investors that followed. ING Groep NV placed 3.6 billion euros ($5.6 billion) of negative valuations in its capital account, while disclosing only an 80 million-euro depletion to income.
The balance-sheet adjustments are in addition to $344 billion of writedowns and credit losses already reported on the income statements of more than 100 banks. These companies have raised $263 billion from sovereign wealth funds, their own governments and public investors to shore up capital. The balance-sheet writedowns also reduce equity, which needs to be replenished. Adding the $35 billion leaves the banks with a $116 billion mountain of losses to climb.
“The smart people are the ones who’ve identified the problems, put them out there in full transparency, and addressed them by raising more capital,” said Michael Holland, who oversees more than $4 billion as chairman of Holland & Co. in New York. “There is still billions of dollars of crap out there that hasn’t worked itself through the system. Banks need more capital to work that all out.”

10-Year P/E Ratios
Posted by Eddy Elfenbein on May 19th, 2008 at 10:29 am

The other day I wrote that the market’s P/E ratio reached a four-year high. Instead of viewing it as overpriced, I said that this is an instance where the market’s earnings multiple may not be a good valuation indicator. The reason is that stock prices are forward-looking and they’re reacting to a brighter outlook a few months from now, even though earnings are still declining. Higher prices and lower earnings translate to a higher multiple.
In today’s Wall Street Journal, Mark Gongloff writes on higher multiples:

Benjamin Graham and David Dodd, the Romulus and Remus of value investing, suggest weighing prices against earnings averaged over a period of as long as 10 years. On that basis, the S&P 500 today trades at roughly 28 times reported earnings. That’s lower than the peak of about 48 at the height of the dot-com bubble, but hardly a bargain; for the past 60 years, that P/E ratio has averaged about 21.

I need to add a few points. Remember that the Price/Earnings Ratio contains one major flaw. It compares two different sets of data. The price is a fixed-point number. You always know what it is at a given point in time. Earnings is a rate. That is, it can only be known between two fixed points in time.
Now I need to stress this point because it’s often misunderstood. Just because price and earnings are different types of data doesn’t mean that it’s worthless to compare them. You can absolutely compare different data points, but you need to realize the limitations. (One recent commenter on my comparison of the Dow and S&P 500 said that the whole thing is worthless because one is market-weighted and the other is price-weighted. That’s incorrect. It’s certainly worthwhile to compare them, but it’s what kinds of comparisons you can draw that’s important.)
The other thing about the P/E ratio is that it’s almost useless in timing the market, but it’s very useful in making judgments about what stocks to buy and sell. If I have a chance, I’ll post more evidence on this point later.
The last point is that I never understood the importance of looking at 10 years’ worth of earnings. Graham and Dodd used that metric but it doesn’t seem very useful to me. Note this recent chart I posted looking at trailing earnings and the S&P 500. What can I say, the relationship seems pretty strong to me. Why would I want to bring in data from 1998? When analyzing market data, the question to ask is how useful is this data? Not, is the data perfect?

Turning Point in the Presidential Election Cycle
Posted by Eddy Elfenbein on May 19th, 2008 at 10:13 am

I don’t place a great deal of faith in these indicators, but we’re nearing a traditional low point in the Presidential Election Cycle.
On average, the Dow is fairly weak from the September 6 of a pre-election year to May 28 of the election. Over that time, the Dow averages a loss of -5.2%. That may not sound like a lot but it’s an average of the entire Dow from 1896 to 2007.
After May 28, the Dow gains an average of 15.2% by the end of the year.

S&P 500 at 19-Week High
Posted by Eddy Elfenbein on May 16th, 2008 at 10:29 am

Yesterday, the S&P 500 closed at 1423.57. That’s the highest close since January 3. It’s also 11.8% above the lowest close of the year, which came on March 10.

Also, has anyone noticed that Nicholas Financial (NICK) is above $7 a share?
With yesterday’s close, the S&P 500’s P/E ratio is at 18.3. That’s the highest level in four years. One small caveat. The P/E ratio often bumps up when the market is a good buy because the earnings are backwards-looking and prices are forward-looking. Trailing earnings are still heading down, but stock prices are up sharply, hence a higher earnings multiple.

The Buy List Year to Date
Posted by Eddy Elfenbein on May 15th, 2008 at 1:46 pm

Through yesterday, the Crossing Wall Street Buy List is down -5.96% YTD. The S&P 500 is down -4.07%. That doesn’t include dividends. The volatility of the Buy List is about 4% greater than the S&P 500.

Tim Brown — Stock Analyst
Posted by Eddy Elfenbein on May 15th, 2008 at 12:35 pm

Former Heisman Trophy winner, Tim Brown, is now (like me), a columnist at TheStreet.com. (Editors note, for clarification, I’ve never won the Heisman.) Here’s a sample from Tim’s debut column:

I am starting with the best of the best: Microsoft. Not only is this a world-class company, it is a steal at this price. It closed at $29.39 on Friday and is much closer to its 52-week low ($26.87) than it is to its high ($37.50).
The idea behind my picks is just like my approach on the field: find a weakness and exploit it. On the football field, I would look for any advantage I could get on the opposing cornerback. In this case, the weakness is not with the company, but rather with Wall Street’s valuation of the company. The Street has unfairly picked on Microsoft, and we will pounce on this opportunity. Not long ago, Microsoft was trading at approximately $35.00.

Oil and the Price at the Pump
Posted by Eddy Elfenbein on May 15th, 2008 at 12:05 pm

This chart is courtesy of GasBuddy.com:

It’s hard to believe that gas was around $2.15 only 16 months ago.

Bernanke was Right
Posted by Eddy Elfenbein on May 15th, 2008 at 11:30 am

Before selling off in the afternoon yesterday, the stock market came close to finishing at its highest point since the very beginning of the year. Since March 17, the S&P 500 has gained over 10%. Not bad for two months’ work.
I think this is a good opportunity to ask if Ben Bernanke’s policies were right, and his actions helped alleviate the worst of the recent credit crunch.
Let me add that I don’t necessarily believe this, and it’s way too early to judge, but now is a good time to take a step back and look at the evidence. Let’s make the argument in his favor and see how well it stacks up. If Bernanke was correct, then his handling of this mess would be far superior to anything handle by the overrated maestro, Alan Greenspan.
Most of the superficial evidence suggests that the financial outlook is much better than it was two months ago. Stock prices are up. Gold is down. Volatility is way down. The microscopic yields on short-term Treasuries have somewhat faded. Inflation is still moderate. Or I should say, the government’s inflation reports are still quite moderate. Best of all, the initial estimate for first-quarter GDP wasn’t nearly as bad as the worst that bears were expecting.
None of these points, by itself, confirms Bernanke’s actions, but taken together, they do give the Fed a nice case to rest on. Let me again say that this isn’t an argument for an economic resurgence, but it’s looking at the worst that we had during the credit crunch. As for me, I don’t care too much for the arcana of monetary policy. If it works, I’m for it.
The weekend of March 15-16 was when we learned that Bear Stearns had gone under and was sold to JPMorgan Chase for $2 a share. This was later bumped up to $10 a share. On Monday, March 17, the S&P 500 dropped to 1276.60, which was just above its closing low from the week before. Then on Tuesday, the Federal Reserve cut interest rates by 75 basis points, which brought the Fed Funds target down to 2.25%. That Dow soared over 420 on Tuesday.
To understand Ben Bernanke is to realize that he’s a student of the Great Depression. For economists, the Depression has long been a puzzle. Why did everything go so badly all at once? According to theory, it wasn’t supposed to happen. That’s the difficulty is that to understand the Depression, you need to discard your textbooks.
On the occasion of Milton Friedman’s 90th birthday, Bernanke said:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

The reason why Bernanke was saluting Friedman and Anna Schwartz, was that they were the ones who pinpointed the role that the Fed played during the Great Depression. According to Friedman, the Depression started off as a garden variety recession, but the Fed allowed the money supply to contract by one-third. This turned the recession into a Great Depression. When their theory first appeared in the 1960s, it was quite controversial. The inflation of the 1970s gave monetarism much more credibility, and by 1976, Friedman had won the Nobel Prize.
According to Milton Friedman, one of the key moments of the Depression came in late 1930. There was run on the Bank of United States. By the way, I didn’t leave out an article, that’s the correct name of the bank, the Bank of United States. It was named that way to fool immigrants into believing that the bank was backed by the government.
The bank was allowed to fail, and bank runs then multiplied. As the banks failed, the money supply shrank. It’s as if the Fed raised rates, which is the opposite of what they should have done. According to Friedman, the Bank of United States was in bad shape, but it wasn’t that bad. Depositors eventually received 94 cents on the dollar. Bad, but not awful.
Let’s jump ahead 78 years. You can see why Bernanke was so concerned about Bears’ failure. The idea of a bank run is perfectly analogous to the issue facing a collapse of bear, but there is the issue of counter-party risk. We should also discuss the issue of whether Bear was bailed out. We often hear about the socializing or risk and the privatization of profit. Let’s recall that in the United States, a great deal of profits, up to 35%, is already socialized. Also, selling a bank of $2 a share can hardly be called a bailout. Though I do have an issue with the Fed backing JPMorgan’s purchase of Bears’ more questionable assets. The environment between now and then speaks for itself.
In March, gold reached an all-time high of $1,033 an ounce. Since then, the yellow metal has backed off to less than $890. At one point on March 20, the yield on the three-month Treasury bill got down to 0.2%. That’s not a misprint. That means that the government could borrow $200,000 for roughly $1 a day. So even though there were complaints of cutting rates too much, market forces were happy to go even lower.
The Fed has for the time being, stopped at 2%. T-bill rates have now risen to roughly 1.8%.
The VIX, which measures implied volatility, has recently dropped below 20. On March 17, it got to 35.6.
I’m not ready to give Bernanke a passing grade just yet, but I happily concede that the worst of the storm has passed.

Whole Foods Bombs Again
Posted by Eddy Elfenbein on May 15th, 2008 at 10:15 am

Whole Foods (WFMI) dropped 14% yesterday on lousy same-store sales results. The stock hit a four-year low.

For the quarter ended April 13, Whole Foods reported comparable-store sales — or sales at stores open at least one year — increased 6.7% from a year-earlier.
In a research note, Citigroup analyst Gregory Badishkanian said investors probably expected Whole Foods to report comparable-store sales growth of between 8% and 9%.
In recent years, Whole Foods had grown its comparable-store sales at rates in the high single digits to low double digits. But analysts said it looks like that growth is easing as the company rebrands Wild Oats stores acquired last August and opens new stores.

This latest bombshell comes less than a year after it was revealed that John Mackey was posting on the Yahoo message boards.
In late 2005, I first called out Whole Foods’ outlandish valuation:

I’m a big fan of Whole Food Market (WFMI), but this stock is way, WAY over-priced. Last quarter, the company missed earnings by a penny a share. In the past few weeks, Wall Street has lowered this fiscal year’s consensus earnings estimate to $2.86 a share, and the stock is still trading at 53 times that. That’s almost as much as Google (GOOG)!
Look, I like organic kumquats as much as the next guy, but let’s be reasonable. Whole Foods’ earnings will probably grow by about 17%-20%. Not bad at all. The stock, however, is already up over 60% this year.
A stock can’t go up faster than its earnings indefinitely. At some point, something’s gotta give. That’s not finance, it’s physics. Right now, the stock is going up because it’s going up. The price and fundamentals have politely parted company. On Friday, shares of Whole Foods closed at another all-time high.

How Many Times Do I Have to Say it?
Posted by Eddy Elfenbein on May 13th, 2008 at 2:02 pm

The WSJ does it again. Every time someone comments on political markets, they have to say that these markets “fail” because the a contract going for over $0.50 didn’t pan out.

John McCain’s presidential campaign is doomed — at least, if you still believe what political futures markets indicate.
At the Irish electronic exchange Intrade, on which people bet on election outcomes and other events, the futures market suggests Mr. McCain has a 38% chance of becoming the 44th president. In the Iowa Electronic Markets, set up at the University of Iowa, Mr. McCain’s Republican Party gets a 41% chance of winning the popular vote for the White House.

No. No. No.
They’re NOT predictions markets, they’re odds-setting markets. That’s something quite different. A 38% chance of winning is not a doomed campaign. I think a baseball player who’s batting .380 would be doing pretty well.
Google IPO’d at $85, today it’s at $585. That’s a $500 miss. Did the market fail? No, they adapted to new information.
As I’ve said several times before, these market are really just for fun and should be seen as nothing more than that.
Still, I don’t understand how people can so often miss this basic fact about the political markets. The markets move with new information. It doesn’t mean that a favored outcome is correct or incorrect. That’s not what the markets are trying to do. They’re trying to analyze new information as quickly as possible. They usually, but not always, do a pretty good job.