Traderbill's Financial Markets Weblog

…you all know the phrase. It has been said of Indians (drunken…TB is 1/4 Cherokee); Italians and Mexicans (lazy); blacks (ignorant)…sweeping generalizations all and the list goes on an on including the sophomoric sexist ones about women. TB’s wife accused him of making generalizations to which TB replied: “yes, but I only use them to make my argument”…and why not? Isn’t that what those running for office do?…including one who ’suspended’ his campaign in a speech that left one wondering if it was even the same man they had listened to for the past three months or so! One pundit labeled it a “perfect speech of conservative values.” You have to love those labels too…talk about generalizations! Dems are all tax and spend liberals who will destroy America…yet the same GOP and especially President that labels them that has been tax and spend for the past eight years while their leader couldn’t find his veto pen…good news he has found it and even used it since the Dems have been in control of the House. He also said in SOTU that he would use it on any fiscal stimulus bill with ‘earmarking,’ despite the fact that the record shows there has been less of this too since the Dems took over. This is not a statement for the Dems as God knows they have their flaws…like the GOP they too play to their extreme base, but the point is: more generalizations.

So before you complete the opening slug, listen to what TB heard Mohammed El-Erian of PIMCO fame said on Friday  …he has returned to PIMCO after a brief stint with the Harvard Endowment and returns to head up their Emerging Markets Group again. El-Erian was interviewed on CNBC  …amazing, a good interview with useful information. When asked about the subprime debacle he said that a little regulation over the past 25 years would have prevented the problem but the total lack of regulation will produce major regulation which in the short run will be detrimental to the markets. Isn’t that what TB has been saying that capitalism’s worst enemies are the activist proponents of capitalism who insist on no controls or restrictions? Larry Kudlow take note.

The funny thing is stock market lore is simply full of generalizations: hemline theory, NFL/AFC, you name it some of the most inane correlations which are simply loosely connected events. Furthermore, even if there is a high degree of correlation you have to understand why they are correlated. Is the current market more like 1930 or the past 25 years? This is important since, as El-Erian says, we have had enormous debt evolve at the personal level (which includes small business). That is why TB puts little stock in those who have seen nothing worse than 1987 in their careers (if that). Even with TB’s 36 years he wishes he had 4 more which would have taken him back to the 1969 tax reform act, as well as the death of the Nifty 50…instead all he has seen is the collapse (and rebuilding of conglomerates), and numerous pie in the sky theories.

Why is investing in stocks so magical and mystical? It is about returns and returns come from reinvested dividends (or coupons in the case of bonds). What has allowed this to occur is the Fed Model which states that the risk on stocks is approximately equal to the 10 yr treasury’s duration of about 7 years. According to a Fed study from 1926-1970 the risk premium on stocks was a huge 7% but from 1970 to 2005 it was just 0.7%! In fact, John Hussman of the Hussman Funds (who writes an excellent newsletter says that from 1982-99 the risk premium was zero (google: stock yields 1980…see for yourself).  

From 1926-89, the dividend comprised 46% of the average 10.3% total return. According to Ibbotson the historical average of dividend yields to 1995 was 4.5% yet as a 2000 WSJ article points out the dividend started declining in 1995 and was 2.31% in 2000…today it is just 2.14%. Without dividends and reinvestment of them, stock performance is nothing to write home about after adjustment for inflation  …but wait…aren’t stocks supposed to be a hedge against inflation?…apparently not.

So we hear on CNBC all day that bonds are rich and stocks are CHEAP! Buy ‘em now…in fact the guys who tell you this would be buying but they are fully invested…nobody ever got rich following a herd.

No back to what makes this so insidious: credit…or more accurately the lack thereof. A lapse at all levels, from transparency, to credit reporting, to credit rating, to monoline insurers, to you, the consumer.

Mark Greene, CEO of Fair Isaacs (are they really fair?) was interviewed on CNN Money on Feb. 8. He said don’t blame us for the FICO scores…this despite adding that the mortgages in trouble are so due to excessive reliance on FICO scores. So who do you rely on if they can’t help you on the individual and Moody’s, S&P, and Fitch fail on rating companies? Greene notes one important point: borrowers are now paying their credit card debt while their mortgages go delinquent…this did not happen in 1994 despite a big drop in home prices then that left borrowers under water…that is because while they may have had negative equity at least they had equity…with 102% financing who cares? Also, it takes months to foreclose and in the meantime you can buy groceries with your credit card!…if you are current!

Latest Bloomberg magazine has a very good article on problems at monoline insurers, including Bill Ackman the young hedge fund manager who warned first of monoline problems and got rich betting against them, and on the founder of ACA who was formerly with Fitch and started ACA to take on insuring lesser quality municipal credits…mainly hospitals…they did good analysis and made money until some whiz kid suggested they insure CDO/CDS over his objections  …they did and the rest is history. Oh, as for him he resigned in protest…could be a good guy to run a reinvigorated monoline insurer. 

Why is it so hard for analysts to say consumption will slow?  …because in their short lives it never has and those who have predicted it will have been proven wrong repeatedly…but this time it IS different…you can make book on that!

Lastly, if you had delved into the Nasdaq seeming disconnect with the rest of the market you would see that it was merely shortcovering in the four horsemen and a few others. There was one exception among the leaders: Cognizant Technology Solutions (CTSH) which added 1.5 to the NDQ 100 due to gapping up on a huge positive earnings surprise…let’s see where it goes from here…and the rest of the market. Since 12/24, CTSH is -11%…-23.7% before the earnings announcement  

As for the four horsemen plus Microsoft here are returns since 12/26 thru 2/8/08: GOOG -27.3%; AMZN -23.6% (since 1/2); RIMM -24.6%; AAPL -36.9%; MSFT -19.8%, while YHOO was down 21.92% from the 10/28 high until the buyout was announced on 1/31…since then it is +52% (but never exceeded the tender price). and is still -13.2% from the high. Alas, CSCO which got hit for warning early, delivered on that warning and is now -18% since 12/24/07. Are they buys?  …you kiddin’ TB? 

Today could be interesting as we pick up the pieces of the rejected hostile buyout of YHOO! by MSFT. Also interesting will be where it plays with GOOG…keep your powder dry…continue to!

All the best! 

TB