Jeffrey Saut on War and Stocks
Posted by Eddy Elfenbein on July 26th, 2006 at 3:30 pm

Whatever the outcome, our sense remains that the various markets will revert to a focus on the issues evident prior to the recent hostilities. Those issues remain a softening real estate market, rising interest rates, high energy prices, inflation, a weakening dollar, P/E multiple compressions, waning earnings momentum, weakening consumer spending, flat wage growth, and declining GDP momentum. And to that GDP point, it is worth nothing that while we have a healthy distrust of the government’s measuring metrics, the one thing you can trust is tax receipts. And surprisingly, tax receipts are growing at around 10%. Ladies and gentlemen, 10% growth in tax receipts just does not “foot” with 2.5% GDP growth. “Somebody” is lying! Either tax receipts are getting ready to collapse, or the economy is going to continue to surprise on the upside. If economic strength is the “call,” then while the Fed may pause at its August meeting, it is certainly not done with its parade of rate ratchets. If, on the other hand, the economic slowing is about to accelerate, the concurrent loss of earnings momentum is not a particularly pleasant environment for stocks.
As for the ubiquitous argument that stock P/E multiples are cheap based on forward-looking earnings estimates, hereto we are skeptical. Indeed, P/E ratios on forward-looking earnings are almost always lower, making stocks look undervalued. That was the case in 2000, 2001, 2002, etc. It is just the nature of Wall Street to overestimate earnings. Yet, the real driver of stock prices is what investors are willing to pay for those earnings, and as we have suggested for the past few years, P/E multiples are compressing due to rising inflation and rising interest rates. And that is why, despite double-digit earnings growth as measured by the S&P 500, stocks have gone nowhere for the past few years. That said, there is always a bull market somewhere and for the past few years we have suggested it was in small/mid-capitalization stocks, “stuff stocks,” Japan, Canada, emerging markets, etc.

Here’s a table on how the market has reacted during different wars (FactSet provided the data).

Chart of the Day
Posted by Eddy Elfenbein on July 26th, 2006 at 3:13 pm

The market has been shifting out of consumer discretionary stocks and into consumer staples stocks. Here’s a chart of the Staples ETF (XLP) against the Discretionary ETF (XLY):

Executive Pay Disclosure
Posted by Eddy Elfenbein on July 26th, 2006 at 2:54 pm

The SEC voted today to require companies to provide more detail about executive pay, including perks. As you may know, I yield to no one is bashing the SEC and tedious regulations, but I honestly can’t get too worked up about this one.
If anything, it will show shareholders that executive pay at most large corporations is a very tiny amount of overall expenses. It sure gets people upset, but it’s not what’s hurting most businesses. Actually, I wouldn’t mind seeing companies go a step further and provide their executive pay in per-share terms. For example, Stanley O’Neal, the CEO of Merrill Lynch, received a very generous stock options grant of $14 million just a few days after 9/11. To be sure, that’s a huge amount of money. But in per-share terms, it works about to roughly 1.5 cents. Since the time of the options grant, Merill’s stock is up $34 a share, which could also be called 3,400 pennies. Are Merrill’s shareholders demanding that 1.5 cent back?
The SEC did not adopt a rule which would require disclosing the income and perks of a company’s highest-paid employees. This became known as the “Katie Couric” rule. Companies complained that revealing the income of celebrities could damage competitiveness. Also, just think of the catfights that would ensue if one actress knew she was being paid less than another. We just can’t have that happening.

Although the final rule dropped the “Katie Couric” requirement, the SEC will seek comment on a less-sweeping approach that would target pay to policymakers at larger companies and their subsidiaries, excluding most professional athletes, television and film personalities, salesmen, traders and investment bankers. As in the original plan, the revised approach calls for identifying highly-paid non-executives by job title, rather than name.

Two things. First, I’m sure that many investment bankers are the highest-paid employees at many conglomerates and financial services firm (talk about catfights). Also, no matter what job title they use, don’t you think we’ll be able to identify which one is Katie?

To combat “backdating” and other abuses in awarding stock options, the SEC will require option grants to be disclosed clearly in tables showing the fair value of the option grant. The closing market price of the stock on the grant date must be shown if it is higher than the option’s exercise price, along with the date the company’s directors awarded the options if it is different than the grant date of the options. If the exercise price of options is different from the closing market price on the grant date, the company must describe its method for determining the exercise price.
In addition, companies must provide more details about option grants to executives in a new compensation discussion and analysis report, explaining methods used in granting stock options, including why a particular grant date was chosen. Other timing questions, such as whether options are granted to executives before the firm issues important information or whether the company times the release of market-moving information to affect the value of executive stock options, also must be addressed in the report.

Again, I really don’t have a problem with this; the more info the better. But I hardly see how this “combats backdating.” Unless the boards has specified it, back-dating is already illegal.

Daniel Gross on the HCA Deal
Posted by Eddy Elfenbein on July 26th, 2006 at 11:24 am

From Slate:

Big business deals usually aren’t ironic, but this one surely is. HCA, a firm founded by the family of the Republican Senate majority leader, Bain, a firm whose founders include Massachusetts governor and GOP presidential aspirant Mitt Romney, and KKR, a firm run by Henry Kravis, a major Republican donor, are betting on the continued expansion of government. HCA’s sale is essentially a $33 billion investment in the idea that government will take an even bigger role in health care. As Les Funtleyder, health-care strategist at Wall Street firm Miller Tabak + Co., put it this morning, “[T]he buyout firms are making a leveraged bet on an improving economy and the prospect of universal health care.”

There’s also the role of Sarbanes-Oxley and nuisance shareholder lawsuits.

Greenspan Was Right
Posted by Eddy Elfenbein on July 26th, 2006 at 11:09 am

Here’s a headline you don’t see often: “Greenspan Was Right.” Bloomberg is coming to the defense of Greenspan’s support for derivatives.

The former chairman of the Federal Reserve has been saying since 2002 that derivatives — financial agreements used to bet on everything from bond prices to weather patterns — actually reduce risks by making financial markets resilient to shocks. He told a Bond Market Association gathering in New York in May that derivatives are the most significant change on Wall Street “in decades.”
At a time when oil prices are above $70 a barrel, the Mideast is exploding and more than two dozen central banks have raised interest rates since May, derivatives are allowing companies to borrow a record $607 billion and obtain relatively cheap financing.
By bundling more than 10 percent of that into so-called collateralized debt obligations, bankers are able to provide more cash to companies, especially those that need it the most. Defaults fell to the lowest since 1997 as sales of CDOs rose 63 percent to $177 billion in the first half, according to the Bond Market Association, a New York-based trade group of dealers and underwriters.

Bernanke’s Financial Disclosure
Posted by Eddy Elfenbein on July 25th, 2006 at 11:40 pm

Just as I suspected, he’s rich:

The chairman’s financial disclosure form, released Tuesday, showed that he’s a millionaire, with holdings last year in no-frills U.S. Treasury securities, Canadian Treasury bonds (???), stock and bond mutual funds and two annuities.
Bernanke, 52, took the Fed helm in February succeeding longtime chairman Alan Greenspan, who also played it safe when it came to his own investments while at the central bank.
An economist who spent most of his career in academia, including teaching at Princeton, Bernanke also is receiving royalties on two textbooks he wrote. Royalty income was listed at between $50,001 and $100,000 for each textbook, the document showed.
Bernanke’s biggest assets last year were two annuities – TIAA Traditional and CREF Stock Large Cap Blend, which were each valued at between $500,001 to $1,000,000. He sold some of his holdings in those two investments last year.

S&P 500 P/E Ratios By Sector
Posted by Eddy Elfenbein on July 25th, 2006 at 6:31 pm

Here’s a colorful chart. This is what the Price/Earnings Ratios have done for the last 18 months for the different sectors of the S&P 500:

While the overall market’s earnings multiple has fallen, it hasn’t been the same across different sectors.
Notice how far Healthcare (the purple line) has fallen. It used be to second only to tech. Now it’s right in the middle.
Financials, which are still very low, have remained pretty steady.

The Market Today
Posted by Eddy Elfenbein on July 25th, 2006 at 4:47 pm

Today was a good day for our Buy List. Fourteen of our twenty stocks rose, and the average stock climbed 0.81% compared with 0.63% for the S&P 500.
The big star today was Brown & Brown (BRO) which jumped nearly 12%. Sheesh, it’s about time! The little insurance stock had been pulling back since the middle of April. Yesterday, BRO reported earnings of 32 cents a share, three cents more than estimates. Alistar Barr at MarkeWatch noted that BRO has benefited from the recent turmoil in the Florida insurance market.
Medtronic (MDT) also had a good day. The stock rose $1.62 or 3.4%. I just don’t see how Medtronic can be 18% off its high.
We had two more earnings reports after the close. AFLAC (AFL) just announced very good earnings. The company’s operating earnings came in at 75 cents a share, four cents more than estimates. The dollar/yen exchange rate nipped off two cents a share. However, the company warned that growth from Japan will be
Also, Fiserv (FISV) reported earnings of 63 cents a share, three cents more than expectations. The company also bumped up its full-year forecast to $2.48 to $2.54 a share from the earlier range of $2.46 to $2.53 a share.

Lagging Small-Caps
Posted by Eddy Elfenbein on July 25th, 2006 at 12:40 pm

Small-caps are having a big day today. In fact, that’s one of few areas of the market that is convincingly higher.
But that’s not how it’s been for the past few months. After a spectacular run, small-caps have been feeling the most pain in this market.
This chart shows the Russell 2000 (black line) against the S&P 500 (gold line):

This is a big change from the previous six years. It’s been one long small-cap party. From April 8, 1999 to April 19, 2006, the Russell 2000 gained 94.7% while the S&P 500 lost -2.5%.

Second-Quarter GDP Report
Posted by Eddy Elfenbein on July 25th, 2006 at 10:24 am

This Friday, the government will report how much GDP grew in the second quarter. I’m curious what this report will say because I think it will be far stronger than most people realize.
The consensus on Wall Street is that the economy grew by 3% for the second three months of the year (this is after inflation). Speaking for myself, I would be surprised if GDP growth comes in any less than 3.4%.
The economy has grown pretty impressively for the last three years. The annualized growth rate is almost exactly 4% (3.997%). That’s faster than the 3.81% growth rate from 1998 through 2000. The fourth quarter of last year was a dud, probably due to Katrina, but we’ve apparently shaken off that slowdown.
For the first quarter, the economy grew by over 5.6%. Once the economy gets moving, it doesn’t often go off the rails so quickly. I should also mention that the GDP report will be updated twice more, and these revisions can be quite big. In fact, I wouldn’t mind seeing the Bureau of Economic Analysis ditch the early reports. I’d rather get good numbers later than bad ones early.
The GDP report will be released this Friday at 8:30 am.