Tuesday, September 9, 2014

Another Omen - Price to Sales

The first indicator most investors check in order to begin to assess the value of the overall stock market is the price/earnings (PE) ratio, which is currently around 18 and just slightly higher than the 60-year average of 16.3. 

But the PE ratio can change a lot depending on the number of years one selects to calculate the average. For example, the Schiller ratio uses a 10-year moving average and calculates the ratio at 26.3. As the last post disclosed, corporations have been buying back their own stock and that alters the ratio by reducing the number of shares divided into profits. 

Wednesday, September 3, 2014

Who is buying?

The Dow is back over 17,000 and the S&P 500 topped 2,000 again this week. Who is buying at these nose bleed levels? According to Jeffrey Kleintop of LPL Financial the buyers are individual investors and corporations buying back their own stock (Hat tip to Christopher Rowe, Director of Investor Education at The Oxford Club)
Currently, there are six notable trends in buying and selling in the stock market. U.S. stocks are being purchased by corporations and individuals; however, foreigners, hedge funds, institutions and insiders are net sellers.
According to data from FactSet, S&P 500 companies bought back about $160 billion in stock in the first quarter of 2014, and are on pace for an amount this quarter that is close to the all-time high of $172 billion set in the third quarter of 2007. Corporations have been decreasing the amount of shares in the market for 10 straight quarters. Over the past year, this has amounted to about 3% of shares outstanding in the S&P 500. 
Why does this matter? Individual investors tend to pile into the market near the top so that they buy high and sell low. Individuals are a small part of the market, so they function mainly as an indicator that the end is near.

Corporate buying is a much larger segment, large enough to overwhelm institutional selling and cause the market to rise. Corporations are borrowing to purchase their own stocks and pump up returns. This deflates the price/earnings ratio by inflating the earnings per share. So while I'm not a big fan of PE ratios as a guide to investing, corporate buy-backs make the ratio even less worthwhile.

But the main problem with corporate buy-backs is that the corporations are borrowing to buy. That pumps up the price of the stocks, makes management look better and in some cases triggers options and bonuses for them.

Kleintop expects institutional selling to continue. So what happens when profits go south and corporations have trouble making the payments on the loans? It will take out the largest group of buyers in the market this year. Most will have to sell the stocks they bought for a loss. That will accelerate any decline in the stock market that follows a bad earnings reporting season.

Wednesday, August 27, 2014

Entrepreneurs in the Big Short

Michael Lewis is the bestselling author of many books, but the first one I have read is The Big Short: Inside the Doomsday Machine, which is about the financial crisis of 2008. Lewis’ economics is terrible, but I still recommend the book.

First the terrible part: Lewis doesn't understand good economics, by which I mean Austrian. From the book I would guess he doesn't know much mainstream economics either. If readers really want to understand the mechanics of how the crises unfolded I would recommend Slapped by the Invisible Hand by Gary Gorton. In a nutshell, it was an old fashioned bank run in which depositors got scared that their deposits were in danger and pulled their money out of the bank. Only in this case the depositors were money market mutual funds, pension funds and insurance companies and the banks were the large investment banks like Lehman and Bear Stearns. But what even the Slapped authorGorton doesn't tell readers is that the run began because of the collapse in the price of housing. It wasn't lightening out of a blue sky.

Tuesday, August 19, 2014

A Viennese Waltz vs a Stumbling Drunk

Mark Skousen is one of my favorite living economists because of my bias for the practical. Skousen has a PhD in economics, but he chose to pursue a career in the private sector as an investment adviser rather than one in academia or government. We need more great economists like Skousen. Their impact will be much greater than that of academics because those of us who need practical advice are much greater than the number of people who will major in economics in college. Also, if you wander through the blogs of Austrian academics you’ll find that academics spend a great deal of time on Quixotic efforts like trying to change Fed policy or reform mainstream economics.

Laissez Faire Books has released a collection of essays by Skousen with the clever title A Viennese Waltz Down Wall Street: Austrian Economics for Investors. It answers the classic book A Random Walk down Wall Street, by Burt Malkiel that promotes the mainstream vision of the Efficient Market Hypothesis.

Thursday, August 14, 2014

Ghost of Ricardo Haunts Europe and Japan

The ghost of David Ricardo must be sending chills up the spines of the economists of Europe and Japan. They may not understand what causes those chills because of the poverty of their education. The US may soon experience a similar visit. Here is how the Wall Street Journal put it in email newsletter:
Can the U.S. go it alone? All of a sudden, economic data from around the world is looking decidedly worrisome. China on Thursday showed stark, sudden slowdown in lending and home buying in July, while Europe’s second-quarter results confirmed everyone’s worst fears, with Germany registering a contraction for the quarter and the euro zone as a whole failing to grow. This comes after a very big slowdown in the same quarter for Japan, the world’s second-biggest economy.

Thursday, August 7, 2014

Omens of the fall

In the ancient world outside of Israel pagan priests discerned the will of the gods through omens in the sky and on earth.  Israelis didn’t need omens because they had revelation straight from God in the Torah. Omens came from the movement of planets and from the structure of kidneys in goats sacrificed to idols. Pagan gods would never have considered humiliating themselves by speaking directly to insignificant humans. The more omens a priest collected the more certain he could be of the will of the gods.

Investors today don’t have a revelation about the future. We have the Austrian business-cycle theory that tells us to expect a crash after years of artificially stimulating the economy with near-zero short term interest rates and massive buying of junk bonds by the Fed. But we can’t know the exact date, or even the quarter, when the crash will come. So like ancient pagans we have to rely on omens that suggest we are near the end of the expansion. These omens are what mainstream economists consider good news about the economy. Here are some gleaned from the kidneys of the Wall Street Journal.

Thursday, July 31, 2014

BIS Pushes ABCT Draws Fire

ABCT investing offers financial advise derived from the Austrian business-cycle theory, so to be confident in that advise investors need to be confident in the theory. The most visible institution promoting the theory today is the Bank for International Settlements (BIS). The BIS is the central bank for central banks based in Basel, Switzerland. Just as the Fed in the US coordinates the exchange of funds for commercial banks, the BIS acts as a clearinghouse that coordinates the international transfer of funds between the central banks of nations. 

Claudio Borio and William White of the BIS have used the ABCT for years to analyze events and create policy. Recently, the bank created a minor storm in the world of economics and central bank policy with the release of its 84th annual report. The report asserts that the loose monetary policies of the world's central banks as well as fiscal policies of governments have failed and continuation of those policies will prove harmful. Mainstream economists trashed the report. Martin Wolf of the Financial Times descended to juvenile language. Gavyn Daviesalso of the FT,  wrote of the report,
The Bank for International Settlements (BIS) caused a splash last weekend with an annual report that spelled out in detail why it disagrees with central elements of the strategy currently being adopted by its members, the major national central banks. On Wednesday, Fed Chair Janet Yellen mounted a strident defence of that strategy in her speech on “Monetary Policy and Financial Stability”. She could have been speaking for any of the major four central banks, all of which are adopting basically the same approach.