9 December 2008 – The Aleph Blog

A Reason to Sell Stocks Amid the Rally

Posted on 9 December 2008 by David Merkel

After I wrote the piece on momentum, I thought, “Wait a minute.? Momentum and valuation are stronger together than separate — run the calculations and write a new piece.

That’s what led to this article.? I added valuation metrics to the momentum regressions for one month and one year returns and found they were of little value.

Ouch. Not what I expected, so I tried momentum and valuation variables to predict ten-year returns. The results for the regression were significant.

Some definitions:

Last year: total return over the last year for the S&P 500
Last month: total return over the last month for the S&P 500
Last 10: total return over the last 10 years for the S&P 500
DP: dividend yield
EP: earnings yield
Int: 10-year Treasury yield
Inflation: trailing 12-month inflation from the CPI
EP10: earnings yield using trailing 10-year earnings.

Trying to forecast ten years into the future, technical variables diminish and fundamental variables show their stuff.? As I have stated before, both current period and long term earnings matter in estimating fair value.? Though I am using Shiller’s data set, it shows that 10-year average earnings are not enough.

That is a big enough finding on its own, but I have something more: using this formula, stocks are expected to earn 2.26%/yr over the next ten years.? After a pathetic decade, do we have another to come?? I(Ask Japan, they have gotten zero over more than 20 years…)

Why might that low return be true?

Bad momentum begets bad momentum.
Government bond yields are low offering little competition to stocks.
Earnings yields still are not high.

Valuations are better than when I wrote the piece, Kiss the Equity Premium Goodbye, but the same problem still exists to a lesser extent.? Where are the projects with high returns on assets that can easily be invested in?? At present, we are not seeing them in bulk.

That is what helps laed me to consider that corporate bonds and bank loans may still be better investments at this point in the cycle — less downside and perhaps a competitive upside.

Tribunes are to Promote Justice among Common Men, Redux

Posted on 9 December 20089 December 2008 by David Merkel

I often fail, and am no good at identifying short candidates because I am not good at timing.? I can spot a bad balance sheet easily, but often companies with the worst balance sheets soar during the bull phase of the market.? What that suggests to me regarding shorting is:

During the bull phase identify bad balance sheets, but don’t short anything.? Make your list of future failures.
Watch for when junk yields rise over 500 bps, then start shorting the names you identified.? There is a risk that you can’t get a borrow, but then buy puts if you can’t get the borrow.

So, maybe I could do shorting.? I’ve gotten a lot of names right, but timing is problematic.? You don’t want to short names too soon, or you won’t be able to carry your position to its demise.? But one name you could not short (using stock) was Tribune after Sam Zell took it private.? I wrote twice about Tribune, and for two reasons:

As I have said elsewhere, it stinks that Sam Zell influenced Tribune employees to invest in a failing business.? It is usually a bad idea to invest in the company that you draw wages from, because it lacks diversification.? Beyond that, if the buyout by Zell had lasted five years, I could argue that the employees had gotten their money’s worth through wages.? As it is, after one year-plus, they got hosed.

It’s sad, and it may get sadder still, as other newspaper holding companies die.? Will the New York Times survive?? Maybe.? What I do know is that its economics are poor, and that they are borrowing against their last solid assets.? Does that sound like a recipe for success?