One Day Down
Posted by Eddy Elfenbein on January 2nd, 2008 at 4:39 pm

Ugh, this is NOT how I wanted to start the year. Believe it or not, January 2 is historically the second best day of the year. Only October 20 has done better.
Every stock on the Buy List closed lower except for little Nicholas Financial (NICK). I told you it was cheap! All told, the Buy List was down 1.58% today compared with the S&P 500’s -1.44%.
The big news tomorrow will be earnings from Bed Bath & Beyond (BBBY).

Investors Haven’t Done Well?
Posted by Eddy Elfenbein on January 2nd, 2008 at 3:10 pm

Dean Baker writes:

In fact, investors in stock have not done very well over the last decade. The S&P 500 rose by a cumulative total of 52.6 percent from December 1997 to December 2007. After adjusting for inflation, the increase was 17.3 percent, which translates into real growth of just 1.6 percent a year. Add in a dividend yield of approximately the same size and we get that the average real return on stocks over the last decade has been 3.2 percent, a bit lower than the yield available on inflation indexed government bonds at the time.

Actually, the equity premium of stocks over long-term Treasuries has been much lower than most people realize. From 1969 to 2005, it’s only been 1.7% annualized. (These numbers are from Ibbotson.) That means investors can reasonable expect nominal equity returns of around 6%.
On the other hand, according to standard valuation models, the market is still very much underpriced. It’s been so dramatic that we could be going through a major shift in equity valuations. This could be one of the big stories of this decade (and hopefully, a post).
Also, the equity premium series is very volatile, so a 10-year period of zero to no premium isn’t that unusual. The 70s were worse and even the 80s don’t look that amazing. Though I would quibble with Baker’s statement that investors haven’t done well. Over the last five years, the total return of the Wilshire 5000 is 93.1% or 14.1% annualized.
(Via Salmon)

Gold at New All-Time High
Posted by Eddy Elfenbein on January 2nd, 2008 at 11:30 am

After 28 years, the price of gold has finally reached an all-time high. Although, inflation has increased by about 170% since then so gold needs to make it to $2300 an ounce to reach an inflation-adjusted high.

Update: Oil just peaked over $100 a barrel for the first time. I should remind everyone that investing in commodities has almost always been a loser’s game. The price of oil, for example, tends to be marked by sharp spikes.
A few weeks ago, Megan McArdle wrote:

One of the things that I was struggling to get across at a dinner a few weeks ago is how discontinuous prices on inelastic goods can be. That is, a few percentage points increase in demand against a relatively fixed supply doesn’t produce a few percentage points increase in price: it can produce huge spikes. That’s not intuitive; we feel as if prices and demand should grow at approximately the same rate. But people in the world have a lot of spare income they can use to bid up the price of oil; the speed with which its price is increasing is a measure of just how useful the stuff is.

If you want to know how well commodities have done, check out this chart of the CRB Index adjusted for inflation:

Nassim Nicholas Taleb on BookTV
Posted by Eddy Elfenbein on January 2nd, 2008 at 7:03 am

On After Words, David Brooks interviews Nassim Nicholas Taleb on the Black Swan. The program is an hour.

The 2008 Buy List
Posted by Eddy Elfenbein on December 31st, 2007 at 9:56 pm

Here’s my 2008 Buy List. For tracking purposes, I assume it’s a $1,000,000 portfolio and each position is worth $50,000. Here’s each stock, ticker, starting price and number of shares. This is what I’m referring to when I discuss how well the Buy List is doing.

Fifteen stocks return from 2007. The five new stocks are Clarcor, Leucadia National, Lincare, Moog and Stryker. The sells are Fair Isaac, Graco, Respironics and Varian Medical Systems. Biomet was bought out for cash in September.
The total market cap of all the companies is $303 billion. UnitedHealth is the largest at $74 billion. Nicholas Financial is by far the smallest at $71 million. The average dividend yield is 0.63%.
That’s it. The list is now “lock and sealed,” and I can’t touch it until next year.

The 2007 Buy List
Posted by Eddy Elfenbein on December 31st, 2007 at 5:35 pm

The 2007 trading year is over. For the year, our Buy List gained 4.99% compared with 3.53% for the S&P 500. Including dividends, the Buy List was up 5.58%, which just barely beat the S&P 500 at 5.49%.

This is impressive if you consider that our Buy List was more stable than the overall market. Our daily volatility was 8.92% less than the S&P 500.

In 2006, the Buy List gained 10.68%, while the S&P 500 was up 13.62%. Including dividends, the 2006 Buy List was up 11.43%, and the S&P 500 was up 15.80%.

For 2007, the best-performing stock was Respironics (RESP) which soared 73.46% followed by Amphenol (APH) which gained 49.39%. The worst stock was Nicholas Financial (NICK) which lost 38.73% followed by Harley-Davidson (HOG) which dropped 33.72%.

I track the Buy List as if it’s a $1 million portfolio. In September, Biomet was bought out at $46 a share. The proceeds were divided up into the remaining 19 stocks. This spreadsheet has more details on how well the Buy List did in 2007.

Here’s how the Buy List did throughout the year:

Relative Performance and the Yield Curve
Posted by Eddy Elfenbein on December 31st, 2007 at 3:58 pm

Here’s an interesting graph, but it needs a bit of explanation.

It’s the relative strength of each S&P 500 industry group relative to the yield spread. The horizontal axis shows the difference between the three-month and 10-year Treasury yield. The far left of the graph shows an inverted yield curve of 1%. As the graphs moves to the far right, the yield curve steepens to 4%.

Two items to mention. First, I used data going back to 1989. Also, I wanted a clean logarithmic graph so I adjusted the starting relative strength number to three. That doesn’t change the scale of the results but I wanted to make that point clear.

If you don’t mind me patting myself on the back, I think this is a fascinating chart. For example, you can see that tech stocks (the green line) do well as the yield curve becomes steeper, however, they run out of breath at the very steepest part. Materials stocks (royal blue), on the other hand, do their best at the steepest part of the yield curve.

You can also see that Utilities (white) do the best when the yield curve flattens out. This is obviously due to their high dividend yields. What I find most surprising is that financial stocks seem to be of the least impacted by movements in the yield curve.

So what does it mean? In 2007, the yield curve started off negative. When the market broke in late February, the spread stood at -0.50. The spread has gradually gotten wider ever since, meaning we’ve moved from left to right. By May, the spread finally turned positive. There was a retrenchment over the summer before the spread shot to over 1.6 in August. The spread currently stands at about 0.9. Here’s a look at the yield spread over the last three years:

Since September, the Fed has cut short-term rates by 1%. If the Fed keeps cutting rates, the spread could reach 2.0 next year. From the first graph, that bodes well for health care (purple) and staples (yellow)—and the 2008 Buy List.

Top 10 Pieces of Happy Economic News
Posted by Eddy Elfenbein on December 31st, 2007 at 1:39 pm

At Bloomberg, Kevin Hassett lists the good stories about the economy:

1) Equity markets posted solid gains and price multiples are still low. As of last Friday morning, the Dow Jones Industrial Average had gained about 7 percent for the year, while yielding about 2.25 percent, providing investors with a total return of more than 9 percent. The Nasdaq Composite Index had climbed more than 10 percent, while the Standard & Poor’s 500 Index had provided a total return in the 5.5 percent range. There are no signs of irrational exuberance. The price-to- earnings ratio for the S&P 500, for example, finished the year at less than 19, safely nestled in the historical comfort range.
2) Households are wealthier. In part because of rising equity markets, household net worth increased in 2007, according to the latest numbers from the Federal Reserve. At the start of the year, net worth was $56.1 trillion. By the third quarter, this climbed to $58.6 trillion and probably rose again in the fourth quarter. If changes in wealth affect the economy through consumption, then the affect will be favorable.
3) Congress did nothing. Gridlock has historically been good for the U.S. economy for a simple reason: New laws are invariably worse than the ones they replace. Witness Sarbanes- Oxley. With the Democrats taking control of Congress, there was a real risk that taxes, in particular, would be increased. With the economy softening already, it is great news that this didn’t happen.
4) The Federal Reserve did something. From interest rate reductions to the introduction of a new auction mechanism to get needed reserves to struggling banks, the Fed has responded to the weakening economy with multiple policy moves. Thus, we have learned that Ben Bernanke’s Fed will likely be a competent actor should things get worse. This is good news for nervous markets, though there was no guarantee this would be the case. The Fed did, after all, aggravate — and may have caused — the Great Depression.
5) The world economy had another blow-out year. According to the latest Moody’s Economy.com forecast, world gross domestic product grew by 3.9 percent in 2007 after rising 3.6 percent in 2006. In spite of the gloom in the headlines, the most important news in 2007 was that economic freedom is spreading, and the benefits to the world’s citizens of this are skyrocketing.
6) The trade deficit declined. As our trading partners become wealthier, they demand more of our products. At the same time, the weaker dollar has made U.S. exports cheaper. Exports have boomed, and the real trade deficit has narrowed, from $624.4 billion in 2006 to an estimated $562.4 billion in 2007.
7) Even in the face of the housing-market bust, economic growth was solid. If someone told me last December that construction of single-family homes would drop in 2007 by 27 percent, about the current estimate from Economy.com, then I would have expected the economy to be in recession. But a collapse of that scale did occur, and annual GDP growth, according to the latest Economy.com estimate, was about 2.5 percent. There are plenty of developed countries that would take that type of growth every year.
8) Job creation was robust. According to the latest jobs report, which covers data through November, the U.S. economy added 1.3 million jobs on net in 2007. The unemployment rate was 4.6 percent in January, and finished the year a smidgen higher at 4.7 percent. Both levels are very low by historical standards.
9) The federal budget deficit declined. According to the Congressional Budget Office’s monthly budget review, the federal budget deficit was only $163 billion for fiscal 2007, a large decline from the $248 billion deficit in 2006. This decline was actually bigger than had been forecast by the CBO last January.
10) Inflation risk is low. Although energy prices surged, core inflation was up only 2.3 percent for the year ended in November, about half a percentage point lower than it was in late 2006. This is great news, making it relatively riskless for the Fed to cut interest rates next year if there are more signs of trouble.

The Fall of Blackstone
Posted by Eddy Elfenbein on December 31st, 2007 at 1:23 pm

Poor Stephen Schwarzman. Just six months ago, the Blackstone Group (BX) started trading at $36.45, a 17% premium to its IPO price. Today, the stock is down to $21.70.

Earnings Preview: Bed Bath & Beyond
Posted by Eddy Elfenbein on December 31st, 2007 at 11:18 am

Today’s the last day of trading for 2007. The market is closed tomorrow. On Thursday, Bed Beth & Beyond will report its Q3 earnings. Here’s a preview from the AP:

OVERVIEW: Home furnishing retailers have suffered as a downturn in the housing market and softer consumer spending take a toll on sales and growth.
Consumers are being pressured to curb discretionary spending due to high food and gas prices and persistent credit problems. Bed Bath & Beyond has been a standout in the sector, however, as it focuses on middle- to high-income consumers which are less affected by the weak retail environment.
The company announced a $1 billion buyback program in September.
BY THE NUMBERS: Analysts polled by Thomson Financial expect a profit of 52 cents per share on revenue of $1.77 billion.
ANALYST TAKE: “Bed Bath & Beyond’s biggest challenge is perhaps living up to its past success,” wrote Deutsche Bank analyst Mike Baker in a Dec. 19 note to investors. “This includes generating among the highest operating margin and return on capital in hardline retailing and driving sales per foot substantially ahead of competitors.”
He rates the company “Hold.”
He added that the company has healthy square-footage growth and cash flow, but its operating margin is being squeezed as competitors offer promotions and same-store sales growth slows.