Monthly Archives: January 2014

the December 2013 Employment Situation

January 10, 2014 By in economics, employment, Employment Situation report Tags: , , , , , , 4 Comments

my day (very skippable)

I was out taking photographs early this morning.  While I was waiting (in vain, as it turns out) for a decisive moment to show itself, I was also rehearsing the form this post would take.

I expected the monthly Employment Situation report to say that the economy had gained, say, +250,000 jobs.  I’d remark that lots of recent anecdotal evidence supported the idea that business confidence was increasing and that the economic growth was beginning to accelerate a bit.  I’d point out that the figures were presaged by Wednesday’s ADP employment report of a gain last month of +238,000 jobs.  ADP’s is a quirky survey, it’s true, but on the money for once.  And I’d observe that the present trend represented a monthly jobs gain of about +100,000 over the number needed to absorb new workforce entrants.  Assuming continuation of this trend for the rest of the year, well over a million workers who lost their jobs during the Great Recession and haven’t been able to find work since would be gainfully employed again.  That’s a really big deal.

S&P futures were up by 7.5 points in anticipation of a strong ES report.  The only short-term investment question would be if, and by how much, futures would rise once the ES was published.

the Employment Eituation report

Well, the actual ES report was bad–very bad.  Bad enough, in fact, that I think the market will dismiss the figures as being a case of seasonal adjustment gone rogue.

a tale of two surveys

According to the establishment survey, the part that generates the job gains and losses, the economy added +74,000 positions in December.  That’s only a third of the job gains in November.  It’s also less than half the number of jobs the economy added on average per month over each of the past two years.

For what it’s worth, the private sector gained +87,000 positions; government declined by -13,000.  Other than retail trade and temporary help, weakness was across the board.  Revisions to past months’ figures were positive, but not close to the magnitude of the December shortfall:  October unchanged, November +38,000.

According to the household survey, the part of the ES that produces the unemployment rate, that fell from 7.0% to 6.7%.  Of the improvement, a third comes from more people having jobs, the other two-thirds from people (mostly men) dropping out of the workforce.  A good number, but a bad reason for it.

my take

It will be interesting to see how Wall Street reacts as equity trading unfolds today.  As I mentioned above, I think investors will ignore the report.

The reaction of the futures to the ES report suggests that the perverse, bond-oriented idea that economic weakness postpones interest rate rises and is therefore good news has passed its use-by date.

The 6.7% unemployment rate is very close to the 6.5% figure that the Fed set as a necessary condition for beginning to withdraw extra money stimulus (remember that “tapering” is just adding extra stimulus, but at a slower rate than before).  But I don’t see any bond market reaction so far.

If I’m correct, next month’s ES assumes greater importance, since the market will likely expect substantial upward revision to the December figures.

gold mining stocks?

January 9, 2014 By in Gold, Industry Analysis, Mining, Portfolio management, Stock ideas Tags: , , , , , , 1 Comment

gold mining stocks

I spent part of the day yesterday looking at gold mining stocks.

the potential attraction?  …over two years of dreadful performance.

Since mid-2011, the gold price is down by about a third.  Over the same time span, many gold stocks have lost between half and three-quarters of their value.  And that’s during a period when the S&P is up by about 50%.

Sentiment about gold has also taken a decidedly negative turn.  Hedge fund managers are no longer bloviating (how about that word?) about the superiority of the yellow metal over “fiat money.”  Boiler rooms are no longer filling the airwaves their odd sales pitch that “Gold has tripled over the past five years.  (Therefore you should) buy some now!!”

In addition, I think that 2014 will be a year of consolidation for the S&P.  So a 3% dividend yield plus the chance of, say, a 15% gain looks to me to be substantially more attractive than it might have been a year or two ago.

my verdict

I’m not so interested, for two reasons:

1.  I think the gold price is still too high.  In the past, the gold price hasn’t bottomed until it reaches a level where at least some existing mines become uneconomical.  This means that the cash a company must spend (not including non-cash costs like depreciation) to produce an ounce of gold is greater than the selling price.  As best I can tell (a long time ago, I would have considered myself an expert, but I’m certainly not one now), that’s below $1,000 an ounce.  The price may never get there, but, as an investor, I’m looking for situations with more upside than downside.  I don’t see that here.

2.  I don’t think companies have completely stabilized themselves yet.  The industry took on a lot of debt to fund what have turned out to be ill-advised capacity expansions at the top of the market.  That’s par for the course.

As far as I can see, these projects have by and large been at least temporarily mothballed.  However, there’s still the debt to deal with.  It isn’t so much that there are borrowings on the balance sheet that bothers me.  It’s that financially leveraged firms have to continue to mine in order to repay their lenders.  So supply isn’t taken off the market as quickly as it might otherwise be.  A number of companies had stock offerings last year.  Good for them, but this just prolongs the adjustment period.

All in all, I don’t find the risk/reward to be favorable enough right now.  Maybe in six months.

 

 

 

 

Madoff and JPMorgan Chase

January 8, 2014 By in Banks, Industry Analysis Tags: , , , , , , 1 Comment

another JP Morgan legal settlement

Yesterday JP Morgan and the federal government announced a deal.  The bank has agreed to pay fines of $2.6 billion and to reform its operating practices, in return for not being prosecuted for offenses relating to the Bernie Madoff Ponzi scheme.

Although the press reports are a bit confusing, the offenses seem to fall into two areas:

–Madoff routinely made transfers in and out of his accounts in excess of $10,000 a day.  Chase did not report these to the government as required by anti- money laundering statutes.  At least some of these transfers were rapid-fire movements from bank to bank, designed to allow Madoff to illegally collect interest on the deposits from more than one institution (“check kiting”).

–Parts of JP Morgan refused to invest the bank’s money with Madoff on the grounds that he was running a Ponzi scheme.  Other parts of JP Morgan happily continued to service Madoff, to buy his products, and to help sell them to others. Also, In the days just before Madoff’s arrest, JP Morgan withdrew most of its own money from Madoff, apparently because of fears of fraud.  The bank notified the UK government of this, but, oddly, not the US.

my take

To me, the plea deal is more evidence of a sea change in the attitude of regulators toward the financial industry since Mary Jo White became head of the SEC.  Long overdue.

In my experience, in every company there’s a tension between politically powerful senior managers who are identified with, and benefit from, the revenues generated by someone like Madoff and the relatively junior researchers who understand the facts better and are more aware of what the law requires.  The former can put up immense resistance to fixing problems.  Their allies can simply refuse to act on, or even to read, the case for a different course of action.

I’ve seen some of the Madoff sales materials.  They assert that phenomenally high returns are to be had with virtually no risk.  No explanation of how this is possible, just a simple appeal to greed.

Current media coverage is highly favorable to government investigators.  What seems to be forgotten is that Harry Markopolos, a financial analyst whistleblower with very detailed evidence of the Madoff Ponzi scheme, repeatedly showed up at SEC offices from 2000 onward to present his case.  He was ignored every time.  (Markopolos was asked by his boss to create a clone of Madoff.  He soon realized that there were periods where no assets delivered the returns Madoff claimed.)

The most elementary checks of the phony documentation Madoff prepared would have revealed the fraud.  But in their periodic inspections, the SEC appears to have checked virtually nothing.  Madoff himself commented on how easy the SEC was to fool.

Value Line: why mechanical systems stop working

January 7, 2014 By in Investment firms, Portfolio management, Value Line Tags: , , , , , , Leave a comment

Sam Eisenstadt of Value Line created a famous computer-driven stock ranking system that worked fabulously for about a quarter century.  Then it stopped working.  Why?

1.  Any economic system is dynamic, not static.  When an innovation happens, it spurs changes in all sorts of other systematic variables.  When a competitor introduces a new product into a market, rivals don’t simply watch their market share erode.  They launch new products themselves, ranging from simple knockoffs of the original innovation to genuinely new, but different, products of their own.

To the extent that “me too” products proliferate, the value/power of the initial innovation is eroded.  In the case of Value Line, post-ERISA, rival money managers poached Value Line IT people to create duplicate systems for themselves.  In fact, a number of very successful value-oriented money managers in the 1970s-1980s were driven, so far as I can see, almost exclusively by their VL ranking system knockoffs.

The fact that many professionals began to act on the system’s predictions–in large size and as soon as the predictions were made–began to blunt the effect of the system.  It tended to make subsequent outperformance smaller in degree and duration.

In short, the Value Line system changed the world  …and then the world began to catch up.

2.  The Value Line system is based on an extensive analysis of historical data.  That was okay when computing power was expensive and when (future-oriented) stock market derivatives were few and far between.   This was also before ERISA turned money management from a backwater into a gigantic business, that is, before brokerage houses and money managers built large staffs of securities analysts churning out predictions of future earnings.

The result of these changes was to reorient Wall Street away from historical earnings to studying–and buying and selling based on–future earnings estimates.  When the actual numbers came out, the market had already reacted.  Not always, but most of the time.

3.  The system has, in my view, a number of quirks, which I’ll just state without elaboration.

–It’s biased toward smaller stocks, which is one reason the VL system did so well in the 1970s.

–I think there’s a semi-permanent underclass of 5-ranked stocks, which makes the 1 vs. 5 comparison less relevant than, say, 1s vs. the S&P 500.

–The system is bad at turning points in the economy, activity either decelerates or accelerates sharply.  In today’s world, investors react to macroeconomic news far in advance of when corporate earnings reflect such changes.

–It works better in down markets, where investors cling closer to reported earnings, than in up.

could the VL system start to work again?

Maybe.  Sam Eisenstadt is a shrewd guy, after all.  Much of the Wall Street information gathering apparatus has been dismantled during Great Recession-induced cost cutting.  We’re unlikely, I think, to experience another decade of macroeconomic and stock market disruption on the scale of the past ten years (at least, I hope we won’t).  So conditions for a system like VL’s to work look to be better than they’ve been in a long time.

The biggest issue I can see is that computing power is no longer expensive.  Most of us could do something like what VL does on our home computers.  I doubt many of us are going to take the trouble, though.

Sam Eisenstadt and Value Line

January 6, 2014 By in Academic Theories, Analyzing performance, Current Market Thoughts, Portfolio management, Value Line Tags: , , , , , , Leave a comment

About a week ago, the Wall Street Journal ran an article about the Value Line ranking system for stocks and its inventor, statistician Sam Eisenstadt.

I knew Sam in the late 1970s – early 1980s, during the heyday of Value Line.  At that time, the company was an incubator that launched the careers of a large number of successful investors.  The ranking system was also a formula for consistent outperformance.

Then the music began to stop.

What I find most interesting about the WSJ article is Sam’s belief that the Value Line ranking system will begin to work again.

how the VL ranking system works

The method, which was revolutionary when it was introduced in the middle of the last century, is taken straight out of a finance textbook.

It evaluates stocks by analyzing two main variables, cheapness and growth:

Cheapness is measured by taking the current price-earnings ratio for each stock and seeing where it stands relative to its PE over the prior ten years.  If the current PE is the lowest, the stock receives the highest score.  If the current PE is the highest, the stock gets the lowest score.

Growth is measured by taking the current per-share earnings growth rate and comparing it with the company’s earnings growth rate in each of the past ten years.  If the rate of growth is currently the highest, the stock gets the highest score.  If the growth rate is the currently the lowest, the stock gets the lowest score.

After scores for each stock are tallied, the totals are compared with those of all the other stocks in the VL universe of about 1,800 stocks–in the early days, this required a mainframe.  A couple of technical variables are mixed in.  The factors are weighted (this is the system’s secret sauce).  The end result is a ranking of the universe in order from 1 to 1,800.

The stocks are then grouped on a bell curve:

–the top 100 are ranked 1

–the next 300 are ranked 2

–the middle thousand are ranked 3

–the next 300 are ranked 4

–the bottom 100 are ranked 5.

Fresh rankings are published each week.

results

For over twenty years, the system worked like a charm.  1s consistently outperformed the market; 5s underperformed (in fact, academic research showed that 5s underperformed more deeply and for longer periods than 1s outperformed).  In most years, stocks performed precisely in line with their ranks.  That is, 1 outperformed 2s, which outperformed 3s, which outperformed 4s, which outperformed 5s.

Academics were flummoxed.  The system was statistically sound.  It used only publicly available historical data.  And yet, contrary to the “efficient markets hypothesis” (the academic assumption that, in simple terms, all publicly available information is immediately factored into stock prices), favorably ranked Value Line stocks outperformed as a group year after year after year.

Then, suddenly, the system didn’t work so well.  The WSJ article has a chart that shows the ten-year annualized performance of the VL 1s minus the performance of the 5s.  That outperformance figure peaks during the first half of the 1980s at a staggering 40% difference per year over the prior decade.  It then begins to fall pretty steadily through 2006, when the performance difference for the prior decade is close to zero.

(An aside:  one might question whether a 10-year time frame isn’t a bit too long or whether having the top 5% or so do better than the absolute bottom of the barrel is a high enough bar–but the author of the article, Mark Hulbert, didn’t go there and I won’t either.)

 

What happened?  Are the bad times over?  That’s for tomorrow’s post.