Capital Ideas & Analysis

I love Carter Worth’s call on WFT and MT. Ive advocated steel through STLD, but MT is a great play as well. right now we’re seeing a cup, but i believe the name is overbought and needs to cool off, i like the formation of a handle. Either way, I agree with the breakout. Same opinion on WFT.

The market is hitting its head on 1387, it has resistance, the 50 MA, OBV and MACD say overbought, but the MACD hasn’t signaled that it is rolling over–yet. The world looks much better, setting higher high, higher low, but risk of a head and shoulders top still exists.

Decision theory, “is the theory of deciding what to do when it is uncertain what will happen.” and that is at the heart of risk management.  In order to make such a decision we need to use things such as sampling, averages, and define what is “normal”. But defining what is expected by the past, we can then reduce uncertainty about the future. This does not limit risk, it defines it.

In order to do this with investments we need to define what the expected outcomes are for each investment class. According to the Case-Schiller index fact sheet, in the past ten years, housing, and RIET’s have outperformed stocks by three percent and 7% respectively. However, there has never been a 20 year period where any investment class has outperformed stocks. Meaning that for the next ten years, the risk of investing heavily in RIET’s and real-estate is higher than average. This gives us a distinct advantage when considering how to allocate funds and what to expect from the future.

Yet, as Daniel Bernoulli first pointed out more than three hundred years ago, “The value of an item must not be based on its price but rather on the utility that it yields.” He goes on to say, “Price and probability are not enough in determining what something is worth. Although the facts are the same for everyone, the utility is dependent on the particular circumstances of the person making the estimate.” In other words, stocks may be the under valued asset in relation to cash, bonds, RIET’s and homes, but owning a home has–for most people–a greater utility. So yes, we can say on just about evey measurable, home prices are over valued. But their utility remains for most individuals.

 In this analysis we can decide that going forward, bonds and RIET’s should be under-weighted. But the weight we place on stocks and buying a home is dependant on–at least in part–their utility. If we need a place to live, or need the relative certainty of owning as opposed to renting, we should be putting money towards a home vs stocks. However, if we do not need such things, stocks should be severely over-weighted for the next ten years.

Next post on this will explore how to allocate equity portfolio’s based on the risk management guidelines set forward here.

Sources: S&P Case Shiller Index,  and Against The Gods, Bernstein. P

Even Ralph Nader could see IGT @ 45 is a screaming buy. Admitedly the cup w/ handle formation is a bit streached, but it still looks like a buy buy buy with a stop around 43, if it turns out this is a double top and not a cup formation, flip it and go short for the long haul.

Outlook and Investment Implications
So where is the neutral rate right now, and more importantly, how low will the Fed go? A simple, back-of-the-envelope estimate would put the “recommended” nominal Fed Funds rate at just about 2¼% right now. We arrive at that by using Taylor’s assumed long-term neutral real rate of 2%, then subtracting a financial-conditions adjustment of about 1% for the spike in credit spreads. This would imply a financial conditions-adjusted neutral real rate of around 1%, from which we subtract another roughly 1% given the output gap that is opening up and the Taylor Rule-recommended monetary accommodation needed to combat it (with a further adjustment for current inflation being above target). That generates a recommended real policy rate of 0%, to which we add the current rate of core personal consumption expenditure (PCE) inflation at 2¼% to get a recommended nominal policy rate of 2¼%.⁸

But considering the Fed’s risk management framework and profound downside risks on the output side, we believe that a more plausible baseline projection for the terminal Fed Funds rate should be lower at 2%. Moreover, the probability distribution of potential outcomes is heavily skewed to the downside, with it more likely to realize a return to 1% Fed Funds within the next 12 months rather than a return to 3%.

The history suggests that a sustained period with real Fed Funds near or below zero is typically required to pull the U.S. economy out of an economic slump. Figure 7 shows that we are not there yet. And the housing market excesses built up during the recent expansion are at least as profound as the credit crunch in the early 1990s and the tech bust of the early 2000s. The housing market hang-over will take time to work off, and a period of very easy monetary conditions will be an essential ingredient in the morning-after remedy.

This points toward continued value in a yield-curve steepener position – though less so than a few weeks ago – particularly in parts of the curve that are historically flat and do not reflect the increased uncertainty about the rate path under a Fed that may be quicker to react to changes in financial conditions in either direction.

Link to full article

I dont know if we will keep this range, but for now the 1320-1368 range is where we have been stuck for about a month. there was a break to the down and upside, but overall we continue the triangle form that i wish i could draw on here. The triangle looks as though it may have broken to the downside, but only time will tell. a break to the upside will be interesting in the high 1380’s, could see some given back at those levels. 1315-1320 on the downside would be crucial.

When attempting to do “value investing” through price to book ratio’s, it is key to take note of ROE. The goal should always to be to find high ROE and low P/B. For high growth stocks, when ROE starts to drop, it is a precursor for P/B dropping as shown in the chart below.

www.stern.nyu.edu/~adamodar/pc/eqegs/IBMROE.xls

also, you rarely find a company with P/B lower than two and ROE higher than 20%, in 1997 there we’re none according to an NYU research paper. In addition, ROE of 10% had P/B’s all lower than 2.  According to further research at NYU, when ROE drops below 12%, it drastically lowers P/B as shown by the fact all ROE under 10% have P/B below 2.  

in addtion; according to this reasearch for every 1% increase in ROE, the PBV ratio should increase by 0.0928. Other research says that for banks, the incrase should only be 0.0532.

The take away is that when looking for low P/B valuation, make sure to check and see what the ROE is. If you can get an ROE above 20%, and a PBV lower than 2, that is real value.

Bespoke Investment Group, which is a great group with a great website, just came out with a post that is supposed to give more creedence to the “decoupling thesis”. however, if you take this back to the 2000 highs, and do the same euro compairison as shown in this chart, isnt this just a long term bear market for US equties? Which is fine, we’ve had these before; 1929-45, 1970-81 and plenty of others before this. So rather than looking at this current market as “the five year bull market ending” we should see this as just another blip in the extended bear market in US equities. that of which started in 1999. If you put the Dow priced in gold, it peaked in 99, and is down 70% since then. If you price the S&P500 in Euro’s, its down 50% from the highs in 99-2000. The most hidden and calm bear market in history.

* Last updated after market close on Monday, February 4, 2008
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When I see the VIX up 8%, TNX down 1.54%,  EUR/JPY taking a huge shot down 1%, and Utilities lighting it up while everyone is selling Retail, Banks, Internet, thats a whole lot of fear. The fear is of course a good thing in some sense, but the play will now have to be high yield utilites and shorting financials with SKF, i think this could be quite profitable. for those less inclined, SDS will work as well.

That’s a picture of a recession. A bit sarcastic–but damn, “the ISM’s non-manufacturing business activity index plunged to 41.9 in January from 54.4 in December. This is the most extreme move on record and the lowest reading since the 2001 recession.” With what i believe to be an obvious recession, i think this one goes deeper, probably longer than the 2001 recession. Simply looking at this statement, its already as low as the 2001 recession, and the latest GDP number was still positive growth. There is plenty of room for an argument of more to the downside for the ISM. Based off of that alone, you can see how easy it is for this recession to be worse.  

The positives for the stock market? when bonds become worthless basically already there) where is the money to go?