Can Sandy Boost GDP?

There seems to be some debate about how much Sandy will affect the economy.  Some think that it will provide a real boost to GDP; others are skeptical.  While it's not possible to know for certain how much will be spent specifically to rebuild from Sandy, loss estimates can help us back into an estimate of how much of a boost the storm could provide to economic activity.  If you assume that the amount of money spent to repair damages is exactly equal to the amount of economic losses, then it's pretty easy to calculate how much that would boost GDP.

Right now the estimate from insurance catastrophe modeling firm Eqecat is that Sandy caused $10-$20B worth of economic damage.  Unfortunately $20B is a small number relative to $15T in GDP--it's only 0.13%.  Even if you assume that the spending will be double or triple the losses, the amount as a percentage of GDP is relatively small.

Source: Arithmetic

Star Wars Franchise Total Worldwide Gross

Disney agreed to buy Lucasfilm for $4B yesterday, which is quite a sum for a company with effectively one franchise, or at least would be if that franchise wasn't one of the most beloved movie series of all time.

Over the course of its lifetime the Star Wars movies have grossed $4.5B worldwide not adjusted for inflation.  Disney released some other numbers to help analyze the transaction:  consumer products licensing revenue for Lucasfilm is expected to be $215m in 2012, and in 2005, the last year a film was released, EBIT was $550m.  That implies about 5-8 films to make back the purchase price (depending on how much you assume they make in a non-film year).  At 1 film every 2-3 years call it a 10-15 year payback period.

Source: Box Office Mojo

NYSE Closures Due to Weather Since 1885

Today's weather related closure of the NYSE is an extremely rare event.  In fact, in 127 years the market has only been closed for the whole day due to weather 6 times, and three of those times were on Saturdays (the exchanges were open on Saturdays up until 1952).  There has only been one time, in 1888, that weather caused a multi-day closure.  For reference, there have been roughly 30,000 trading days since 1885, which makes today a black swan of its own--a four sigma event.

Below is a list of all the times that the NYSE has ever been closed or partially closed due to weather.

A list of every day that the NYSE has ever been closed can be found here.  (a lot of history in that list).

Will Sandy Affect Economic Data?

With Sandy shutting down much of the east coast today, it's likely that there will be some effect on economic data, but it's tough to say how much until the storm actually hits.  Typically initial jobless claims can be one of the more sensitive indicators to week to week variance.  In 2005 Katrina caused a clear spike in the national numbers, although I don't think anyone expects Sandy to cause anything close to the damage that Katrina did.

4 Wk Moving Average

A Weekend of Abnormal Weather

While you all on the east coast will be bracing yourselves for a snow-hurricane this weekend, we in Los Angeles will be "enjoying" 90 degree weather.  It's true that LA is often warm year round, but it's not usually this warm.  We are in the midst of a Santa Ana wind cycle, when warm winds blow through the city spiking temperatures with a dry heat in the middle of Fall and Winter.

When I was in high school, I took an English exam on a Joan Didion essay about Santa Ana winds, which has always stuck with me for some reason.  In the piece, Didion writes that the winds make people do crazy things en-mass.

As market participants, none of us should be a stranger to watching people do crazy things en-mass.  It's been my experience that sometimes the best explanation for crazy behavior is simply that there's something in the air.  I'll let Didion handle the rest:

There is something uneasy in the Los Angeles air this afternoon, some unnatural stillness, some tension. What it means is that tonight a Santa Ana will begin to blow, a hot wind from the northeast whining down through the Cajon and San Gorgonio Passes, blowing up sand storms out along Route 66, drying the hills and the nerves to flash point. For a few days now we will see smoke back in the canyons, and hear sirens in the night. I have neither heard nor read that a Santa Ana is due, but I know it, and almost everyone I have seen today knows it too. We know it because we feel it. The baby frets. The maid sulks. I rekindle a waning argument with the telephone company, then cut my losses and lie down, given over to whatever it is in the air. To live with the Santa Ana is to accept, consciously or unconsciously, a deeply mechanistic view of human behavior.

I recall being told, when I first moved to Los Angeles and was living on an isolated beach, that the Indians would throw themselves into the sea when the bad wind blew. I could see why. The Pacific turned ominously glossy during a Santa Ana period, and one woke in the night troubled not only by the peacocks screaming in the olive trees but by the eerie absence of surf. The heart was surreal. The sky had a yellow cast, the kind of light sometimes called “earthquake weather.” My only neighbor would not come out of her house for days, and there were no lights at night, and her husband roamed the place with a machete. One day he would tell me that he had heard a trespasser, the next a rattlesnake.

“On nights like that,” Raymond Chandler once wrote about the Santa Ana, “every booze party ends in a fight. Meek little wives feel the edge of the carving knife and study their husbands’ necks. Anything can happen.” That was the kind of wind it was. I did not know then that there was any basis for the effect it had on all of us, but it turns out to be another of those cases in which science bears out folk wisdom. The Santa Ana, which is named for one of the canyons it rushes through, is a foehn wind, like the foehn of Austria and Switzerland and the hamsin of Israel. There are a number of persistent malevolent winds, perhaps the best known of which are the mistral of France and the Mediterranean sirocco, but a foehn wind has distinct characteristics: it occurs on the leeward slope of a mountain range and, although the air begins as a cold mass, it is warmed as it comes down the mountain and appears finally as a hot dry wind. Whenever and wherever foehn blows, doctors hear about headaches and nausea and allergies, about “nervousness,” about “depression.” In Los Angeles some teachers do not attempt to conduct formal classes during a Santa Ana, because the children become unmanageable. In Switzerland the suicide rate goes up during the foehn, and in the courts of some Swiss cantons the wind is considered a mitigating circumstance for crime. Surgeons are said to watch the wind, because blood does not clot normally during a foehn. A few years ago an Israeli physicist discovered that not only during such winds, but for the ten or twelve hours which precede them, the air carries an unusually high ratio of positive to negative ions. No one seems to know exactly why that should be; some talk about friction and others suggest solar disturbances. In any case the positive ions are there, and what an excess of positive ions does, in the simplest terms, is make people unhappy. One cannot get much more mechanistic than that.

Asset Backed Commercial Paper Market Size

Before 2008 Asset Backed Commercial Paper (ABCP) was central to the shadow banking system.  ABCP was issued by special purpose vehicles (SPV's), which held a pool of longer term asset backed loans.  After 2008, most of the SPV's that issued the ABCP went into run-off mode, hence the decline of the shadow banking system.  Today, that process is surprisingly almost complete for the ABCP market.  The amount of ABCP left outstanding has fallen by $1T since 2007, about $200B per year.  At that pace, there's about 1.5 year's worth of ABCP supply left.

How Many Words Does it Take to Describe a Business?

After AMZN's report last night and surprisingly positive stock reaction, I decided to turn to the annual report for some perspective.  I was stunned by how little information the company actually provides to its shareholders.

The entire description of AMZN's business is only 1000 words--3 pages.  Amazon web services is described in one sentence: "We serve developers and enterprises of all sizes through Amazon Web Services (“AWS”), which provides access to technology infrastructure that enables virtually any type of business."  Rackspace takes 3700 words to describe a similar business line.

For a sense of how out of the ordinary AMZN's bare bones description is, below is a list of the number of words it takes other large tech, internet and retail companies to describe their business lines.  Most are about 4x as long.  Length does not necessarily equal strength, but does imply some extra information.

Certainly, AMZN isn't just a company of few words either.  Where there's legal liability involved the company is plenty verbose.  The risk factors section is 5826 words and the legal proceedings section is 3812 words.

Monetary Base Still Not Growing

Even though QE3 has now been in effect for over a month, the monetary base hasn't budged since it was announced.  As I've documented before, the monetary base has been highly correlated with commodity prices since QE began in 2008, so the fact that the base has not broken out higher could help to explain why crude and gold are also failing to make new highs.

Dollar Correlation with Romney Since Debates

Over the last few years, the dollar has had a strong negative correlation to equity and commodity prices.  When the dollar has weakened, equity prices have generally risen and when the dollar has strengthened equity prices have usually fallen.

For most of that period, risk on/risk off mentality plus a nice dose of QE 1,2 and 3 have been the major forces affecting the dollar.  In recent weeks there has been another factor at play though which has been interesting to watch.  Ever since Romney's strong performance at the first presidential debate, the market has started to price in the possibility that he could actually win.  This would have big implications for the Federal Reserve, QE and the dollar, because most expect Romney to push for an end to QE.  As such, the dollar has started to trade with some correlation to the Romney intrade contract.  In the last few weeks, when Romney's odds of winning increase, the dollar (measured by DXY) increases as well.

Importantly, most people seem to think that a Romney presidency would be a positive for equity markets; however, a Romney presidency would likely mean a stronger dollar, which could mean lower equity prices if the correlation holds.

What Did Warren Buffett Want to Buy?

And now for some pure speculation...

This morning on CNBC, Warren Buffett said that he almost bought two different companies for $20B this year and may be looking at a 3rd company that could be purchased for $6B.  Below are some possible names that he might have been alluding to based on a few Buffett-based assumptions 1) He wouldn't pay more than a 30% premium to current price (Burlington Northern and Lubrizol were each purchased at ~30% premiums) 2) He likes companies with long operating histories and better operating metrics than peers 3) That are in industries that he understands well (close to companies that he already owns).

Possible $20B Acquisition Targets

Archer Daniels Midland (ADM: ~$18B):  In my mind this is the most likely candidate for a Buffett acquisition of this size.  He's actually said in the past that ADM is the type of company that he likes to invest in.  It's a Midwest company and Buffett knows agriculture well.  He frequently talks about owning farmland and in fact does own a farm that his son Howard runs.  Howard Buffett also happens to have been on ADM's board from 1992-1995.  Buffett is the ultimate collector and ADM is possibly a trophy that he has long coveted.

Kellogg (K: ~$18.5B), Heinz (HNZ: ~$18B), or Hershey (HSY: ~$16B): I lump these three together because all are in relatively similar businesses with similar price tags.  Buffett knows packaged consumer goods businesses well as already owns/has owned P&G, Kraft, Coca-Cola, See's.  All three possible targets have good timeless brands and we know he has a sweet tooth.

Sherwin-Williams (SHW: $15B):  Buffett knows the housing and chemicals spaces.  He owns a lot of housing and construction related businesses already, so SHW would fit into the portfolio.  It has had a huge run recently, but a Buffett bid whisper might actually help to explain that.  He had been silently buying IBM for months before anyone knew.

McGraw Hill (MHP: $15B):  This might be more of a long shot because he already does have a large stake in Moody's, but McGraw Hill is a crossroads of a two types of businesses that he likes: financial services and publishing.

Possible $6B Acquisition Targets

H&R Block (HRB: $4.7B):  Could it be?  Buffett has owned the company in the past but liquidated his stake in 2007.  Buffett did say that he already knew the company in question, but he knows most companies at this point.  The problem is that HRB has turned into a dysfunctional company with a messy legacy sub prime exposure and is getting beaten badly by INTU.  My guess is that if this is the company he was referencing, he'll realize he doesn't want to take on the risk once he looks at the financials.

Gannett (GCI: $4B): He has always loved publishing and media businesses even if they are somewhat old world.  Arguably, USA today is one of four national newspaper brands besides the New York Times, the Wall Street Journal and the Washington Post (which he of course owns already).  There are also about 100 local newspapers owned by Gannett which is a business that Buffett also feels is more protected from new media.

International Flavors and Fragrances (IFF: $5B):  A bit of a dark horse perhaps, but it has been in business in since 1833--a specialty chemicals company in an oligopolistic market that creates and licenses scents and flavors for consumer products.  A really nice niche business that might be buy-able for $6B.

Tablets are not Laptops--Excerpts from Gizmodo Surface RT Review

Most of Wall Street seems convinced that PCs are dying and that tablets and smartphones are going to take over the world.  As someone who believes that tablets and smartphones are supplements to PCs at best, a few lines from a review of the Microsoft Surface RT tablet caught my eye.

http://gizmodo.com/5953866/microsoft-surface-rt-review-this-is-technological-heartbreak

The review is mixed/negative because Surface RT promised the hope of more productivity on a tablet but doesn't deliver. Importantly, the author does note that there is a higher priced surface (running on an Intel processor) that might get closer to PC productivity. I thought these quotes were worth re-posting:

"The laptop is about as far advanced as one can imagine. The MacBook Air and a horde of ultrabook clones are hitting a brick wall in terms of form and physics. The tablet, likewise, isn't exactly pushing civilization forward; it's still fundamentally a luxury device, a delightful toy for reading email on the couch or watching Netflix on an airplane. Nobody needs a tablet. It's a lovely, superfluous thing. But everyone needs a computer, unless you're planning on living by a lake and trading furs for a living." 

" Desktop mode is entirely worthless in RT, a cruel tease of non-functionality. It'll only remind you of how much you can't do with your Surface, and is going to confuse the living hell out of most people who buy one—especially when Surface Pro, built on x86 architecture and perfectly compatible with all of those legacy programs, steps in a few months from now."

Breadth of Todays Decline Wasn't that Bad

Considering that the S&P 500 was down 1.4% today and that futures were off hard this morning, the breadth of today's decline could have been worse.  72% of NYSE issues declined on the day and only 61% of the NASDAQ was down.  For comparison, below is a list of all the days this year that the S&P 500 has fallen by 1% or more and the breadth of the decline on those days.  On average 80% of individual issues posted declines on big down days.

Debate Word Count

Below is a frequency analysis of the number of times that nations were mentioned in last night's foreign policy debate.  Almost the entire discussion focused on the Middle East, with some references to China.  In all, the 10 largest countries in the world plus our 4 largest trading partners not in that category were mentioned 42 times.  Without China they would've been mentioned 10.  Meanwhile six Middle Eastern countries were mentioned 141 times.

While one might argue that there isn't any reason to talk about regions that aren't top of mind, "Europe" was mentioned once during the debate and last I checked there are some pretty big things going on in that part of the world today that the next POTUS may want to opine on.

Two More Charts For the Growth Graveyard

With NFLX, OPEN, and GMCR already cut down, two stocks loathed by value investors: CMG and MNST are finally ready to be added to the list of broken growth stocks.

Still on tap: AMZN, WFM, CRM and LULU will likely look like these eventually.

Length of Fed Chair Terms

There are reports this morning that Ben Bernanke wont stand for re-appointment as chairman of the Fed even if Obama wins re-election.  Considering that only a month ago he pushed to extend QE indefinitely, leaving now seems equivalent to changing pilots mid flight. Still, Bernanke has been chair for 6 years.  How does this compare to the term length of other chairmen?

At a little under 19 years, William McChesney Martin held the post for the longest period, which Alan Greenspan nearly matched.  Eugene Black had the shortest term at 15 months.  The average term length is ~7 years.

Significantly Fewer Google Searches for Windows 8 Than Previous Versions

Windows 8 will be released on Friday and the buzz certainly feels muted compared to what one might expect for a big product launch from a company that still owns >90% of the PC market.  In an attempt to quantify the buzz, below is Google trends data for each of the last 4 windows releases.  Windows 8 search volume is a lot lower than its predecessors.

Federal Reserve Districts by Population

This post wasn't spurred by anything in particular, but I thought it was interesting to think about the fact that the 12 Federal Reserve districts are far from evenly distributed in terms of geography, population and deposits.  For instance, the San Fransisco district contains 20% of the population and New York contains 65% of the system's deposits.  Originally some of the existence of the regional banks was necessitated by the needs of processing physical money and checks, but with electronic currency that function is less necessary today. 

In 2006,  Tom Hoenig wrote an interesting piece defending the 12 bank system which can be found here.  The structure of the Federal Reserve as 12 banks says a lot about American political values, especially in 1913.  We are a nation that has historically fought passionately over the idea of federalism vs. centralization of government power.  The choice between Hamilton and Jefferson is what forms the backbone of American political history.  1913 marks somewhat of a crossroads of a Jeffersonian age turning slightly more Hamiltonian.  Today Hamilton firmly has the upper hand, but perhaps eventually the pendulum will swing back the other way with major implications for the current political-economic paradigm.

Is October 19th Cursed?

There are still 12 days to Halloween, but October 19th is quickly shaping up to be the spookiest day of the year for investors.  Today is the 25th anniversary of the 1987 crash and the Dow is down nearly 200 points.

Looking at historical performance on the 19th though, there's not anything extra-ordinary to worry about.  It's just a day like any other, albeit one that does average slightly negative returns.  On average, the Dow has been down 0.5% on all October 19th's since 1900.  If you exclude 1987 that figure is -0.2%.  However, of the 80 October 19th's on which the Dow has been open, the index has been positive on 39 of the days or about 50% of the time.

What Was the Performance of the PPIP Program?

My previous post about unreturned TARP funds got me to wondering about PPIP and how the asset managers who participated in the program ended up doing.

For those who may not remember, during the financial crisis there were supposed to be all sorts of toxic "legacy securities" sitting on bank balance sheets.  The government spent a lot of time trying to figure out a way to remove these securities from bank balance sheets without 1) overpaying 2) causing the banks to incur a loss so great that it would impair their capital.  One solution was the PPIP (Public Private Investment Partnership) which effectively turned the US Treasury into a prime broker for 8 very lucky hedge funds.  The idea was to take 50% private money, 50% public money (as equity) and then double that with more public money (termed as debt (even though it's all debt anyways)) and use that to buy the riskiest securities that could be purchased off of bank balance sheets.

In all, $7.3B of private money was combined with $22B of public money to form PPIP funds.  The funds were structured to shutdown in 2012, and many of them will end their investment period this month.  As the financial crisis fades deeper and deeper into memory, the PPIP funds have been mostly forgotten as well, but the Treasury still does report on how they've done on a quarterly basis.  Below is the performance of the funds, which have on average earned an 88% cumulative return since 4Q09.  For its part, the treasury earned a return of 1.48x its equity (after fees).  Over the same general period, the S&P 500 is up about 40%. More information on the PPIP program can be found: here.

PPIP Fund Performance

How Much TARP Money is Still Unrepaid?

Below is a great infographic from Businessweek tracking how much Federal bailout money has been redeemed and how much is left unrepaid.  $174B is still yet to be paid back.  The main categories yet to repay are: Fannie/Freddie, the auto companies and some PPIP funds (remember those)?

Click to Enlarge

Natural Gas Inventories

Earlier in the year a warmer winter than usual helped contribute to much higher than usual natural gas inventories.  This led to a big pullback in natural gas drilling, which has contributed to an overhang on much of the energy sector for most of 2012.  Now that we're into the 4th quarter when natural gas inventories typically hit their peak, the oversupply situation has finally begun to abate.

USB Management on Fiscal Cliff

US Bank management thoughts on consumer credit impact of the fiscal cliff, from 3Q Earnings call:

P. W. Parker - Chief Credit Officer and Executive Vice President

Well, if the worst case happened on the fiscal cliff, I think it's fair to say we'd probably reenter a recession. And that would be then you'd see unemployment go up, and that would have an impact on consumer portfolio. I'm hopeful that they come to some kind of resolution, and I think the fiscal cliff was designed in such a way that it's so severe. I think it's unlikely that there won't be some political solution that cuts the middle ground and mitigates that risk.

Dow Jones Monthly Gain Streaks

As of the end of September, the Dow has only had one down month in the last 12.  If the market closes the end of October where it is today, the Dow would have risen in 12 out of the last 13 months.  For a look at how this compares to history, below is a table of other big Dow monthly gain streaks that were only interrupted by one down month.  I'll dub these 1 hitters--almost perfect games but gave up one month in the middle of a hot streak.

There are only 4 other occurrences in 112 years that the Dow has had a longer one-hit streak than the current one.

Citi Share Price Performance Under Pandit

Vikram Pandit unexpectedly stepped down from the head of Citibank today, which caps off a troubled run.  Pandit was thrown into an impossibly difficult situation on December 11, 2007, but it's tough to say that his time as CEO was successful.

Under Pandit, Citi's shares lost 88% of their value, which is the worst performance of any large bank that's still standing.  While there's not much that Pandit could have done to prevent the decline, he may have been able to mitigate it if he had controlled the dilution of his shareholders a little better.

Many may not remember, but Vikram Pandit allowed Treasury to convert TARP money from preferred to common shares on February 27, 2009, just days before the market bottomed.  It was the only major bank that did so at that time.  We may never know to what extent he was forced to do this, but we do know that Pandit himself was the one who caused the bottom in the stock market only 10 days later.  He sparked a massive rally when he quietly leaked that Citi had been profitable for the first two months of the year.  Why did Pandit subject his shareholders to such heavy dilution when things were so much better than the market realized?  Sadly, Citi shareholders may never know.

INTC 3Q Conference Call Notes

Snippets from this afternoon's call:

"PC related billings improved in September over the July and August levels.

In the coming months consumers will see tremendous phone factor and industrial design innovation. There will be more than 140 core based ultrabooks, more than 40 of which will have touch. This will include more than a dozen convertibles that combine the productivity of the laptop with the convenience of a tablet.

We significantly cut factory loading at the end of the quarter and we will maintain lower factory utilization rate throughout the fourth quarter

I don’t think that the tablet as we’ve seen it evolve over the last several years is the end state of computing, the innovation is going to start pouring in now"

Abstract Painting (809-4) Gives Clapton 21% Annualized Return

There was an article in the Journal today about a painting by Gerhard Richter entitled Abstract Painting (809-4) which sold for $34m, the highest price ever for a living artist's work.  The article mentions that the painting was purchased by Eric Clapton for $3.1m in 2001, which is a 21.2% annualized return.  For comparison, AAPL has given a ~41% annualized return and Gold has returned ~16% per year since then.  The S&P has returned about 1.5% before dividends in the same time.

September Retail Sales

Retail Sales numbers released this morning were reasonably strong, up 1.1% for the month of September and 5.3% y/y.  Sales at general merchandise stores stood out as a weak point though.  General merchandise sales make up about 12.5% of the total and were down 1.1% year over year.

A summary of retail sales data and the categories that make up General Merchandise are below.  Census doesn't break out specific businesses that make up each NAICS category, but it's probable that Walmart, Target and Costco would be included in the category.

How Often Does the S&P 500 Trade Below its 50 DMA?

Given the choppy trading environment that we've been going through recently, the S&P 500 is getting closer to trading at its 50 day moving average.  Since the market has generally been up this year, it hasn't spent much time below that mark.  In fact, out of 195 trading days in 2012, the S&P has only spent 45 days or 23% of the time below its 50 day moving average.  How does that compare to history?    In 65 years of history, the S&P trades below its 50 DMA about 37% of the time.  In 1995 there was only 1 day that it was below the average and in 2008 it spent 195 days below it.

Q3 Bank Earnings Preview

JPM will kick off earnings season for financials tomorrow, and the whispers seem to be that the quarter is going to be pretty good.  Hopefully JPM will show signs that the banking system is continuing to heal and that profitability is returning.  Whereas a couple of years ago investors would have had a laser like focus on capital and asset quality metrics, this quarter the metrics that I'll be paying close attention to are (among others): Return on Equity, Loan Growth and NIM.  Below are charts of how these have trended for the banking system over the last decade.

While asset quality has gotten a lot better for the aggregate portfolios and charge offs have slowed to pre-recession levels, banks are still holding a lot of non-accrual assets in their residential books.  It will be important to see if the system is taking the opportunity provided by improving housing prices to finally clean their books completely.  This will have major implications for future lending.

Zynga Enterprise Value

Perhaps the only thing more amazing than ZNGA's share price collapse from $15.91 in March to $2.30 today is the fact that the company still has $1.1B worth of net cash and securities on its balance sheet.  The market cap of the company is only $1.7B now which means that the Enterprise Value is about $600m (even less if you give credit for real estate holdings).  Equally amazing is that the company $1.2B in revenues but can't turn an operating profit.

I think it's safe to say that ZNGA is the most extreme growth/value stock identity crisis in the market today.  On the one hand it flashes signals that it is a deep value stock (EV near 0) but on the other hand it has trademarks of a momentum/growth stock (early in it's life, not focused on profits, formerly hot sector).  So which is it?

What Percent of Bank Holding Company Assets are Held at Commercial Bank Subsidiaries?

The New York Fed is putting together a new banking industry report which can be found here.  It's not as comprehensive as the one that the FDIC puts together on a quarterly basis, but it is valuable in that it goes beyond just the commercial bank subsidiary and looks at the whole bank holding company.  As the following chart shows, less than 80% of assets consolidated on an average Hold Co's balance sheet are held in the commercial bank.  Some other interesting data on BHCs is also below including geographic exposure of systemic assets (i.e. to Europe).

Best Performing Stocks Since 2007 Peak

In order to celebrate the five year anniversary of the highest point in the S&P 500 set at 1561, I put together a list of the best performing stocks since that day.  While it's probably not surprising that AAPL is at the top, there are certainly some surprises on the list.  Dillard's, at #2, flies almost completely under the radar but has more than tripled over the last 5 years.

US Government Expenditures Compared to Other G7 Countries

Yesterday I posted a chart which showed a history of US federal government expenditures per capita.  For comparison, below is a chart of how that number stacks up to other G7 countries.

As a side note, the data is all in USD, and the US number is different than in the last post because this data includes State/Local government expenditures.

AAPL's Last $100 Decline

At $633 per share, Apple is coming close to giving up $100 in share price for the first time in a long time.  The only other time that the stock has hit a new three digit handle only to fall back to an old one was thanks to the financial crisis.  At the end of 2007 Apple hit $200 but fell below $100 in 2008.

Federal Government Spending Per Capita

Alexis de Tocqueville is often misquoted as saying that "the American Republic will endure until the day Congress discovers that it can bribe the public with the public's money."  Whether you agree with that sentiment or think that it's best that the government does provide social benefits to its people, below is the current price tag for Federal government services per capita.  CPI adjusted we spend more today per person than we have at any time in the post-war period.

October 2012 Investor Letter

Below is a letter that is written monthly for the benefit of Avondale Asset Management's clients. It is reproduced here for informational purposes for the readers of this blog.

A lot changed in September.

The S&P 500 finished up 2.5% for the month and up 5.5% for the quarter, but if you blinked you may have missed most of the gain because almost all of it happened on two days. On September 6th and September 13th the index rose by a combined 52 points or about 3.7%. Counting that and the 33 point gain that happened on the last day of June, 85 out of the 193 points that we have rallied from the June lows have come on three trading days.

Each of those three days had an important commonality: central bankers drove the market. Back in June, the market rallied when Mario Draghi hinted that the ECB might be working on a new plan to save the Eurozone. On September 6th he rekindled that hope with a pledge to buy an unlimited amount of sovereign bonds if things got worse. Then on September 14th Ben Bernanke outdid him by not just threatening but committing to open ended bond purchases.

This most recent round of easing represents the most radical Fed move yet because it takes money printing from a finite proposition to an infinite one. The Fed has said that it won’t stop printing money until the economy is well into recovery, and has thus given everything it has left to try to stimulate near term economic activity. If this fails the only option remaining is to print even more rapidly or perhaps buy riskier securities.

If the economy reaches Bernanke’s goals, it will likely be in spite of QE3, not because of it. At its most fundamental level, the point of QE is to manage market psychology and awaken Keynes’ “animal spirits.” Bernanke is certainly changing market psychology, but I’m not sure that he is doing so for the better. I have yet to hear a CEO say that he or she is more likely to hire another worker because the Fed has pumped another trillion dollars into the economy. Unfortunately there is zero empirical evidence that money printing can lead to real economic growth. On the other hand, there is plenty of empirical historical evidence that it can lead to inflation.

QE3 creates more inflation risk than either of its predecessors because the economy is not nearly as impaired as it once was. We are no longer in the juicy part of the cycle when economic indicators can slingshot higher as the economy moves from a low level of capacity utilization to a high level. The “V” has occurred, and now earnings are beginning to flat-line. This doesn’t mean that they have to go down, but it does mean that the economy is reaching its potential output. High capacity utilization plus stimulus leads to CPI inflation.

For our portfolios this means that we will be making some significant adjustments before the year is done. In the near term, I continue to expect a market pullback on the realization that earnings growth is slowing, but in the long term, cash is quickly losing its status as a safe harbor, and we hold too much of it. Counter-intuitively, equities are becoming one of the safest assets to hold because earnings will eventually grow with inflation. However, most investors continue to pull money out of equities, which could create the right circumstances for a blast higher if individuals ever felt the need to get back into the market, like if rates started to finally move higher...

Scott Krisiloff, CFA


Opinions voiced in the letter should not be viewed as a recommendation of any specific investment. Past performance is not a guarantee or reliable indicator of future results. Investing is subject to risk including loss of principal. Investors should consider the suitability of any investment strategy within the context of their personal portfolio.

Monetary Base Since QE3

The monetary base is an indicator which I always pay close attention to because it has been highly correlated with the price of oil and gold since 2009.  Since QE3 was announced I have been paying even closer attention to the measure than usual, but it hasn't yet moved as one would expect it to.  Over the last several weeks the monetary base has fallen as the Fed has purchased more MBS for reasons that  I don't totally understand (likely some technicality and timing of the way assets are accounted for in the Fed's H.4.1 release).  I would expect this to reverse in the coming weeks, but until it does, it may help to explain why oil has been weak since QE3 as well.

Duration of Economic Expansions

From time to time one may still hear analogies linking our current economic period to the Great Depression.  Most know that the Depression consisted of two separate recessions, one which started in 1929 and the other in 1937.  The intervening period was technically an expansion but wasn't much to write home about.  

Our current economy is also often compared to the 1970s because the stock market went sideways for about a decade during that time as well before ultimately culminating in the early 80s inflationary recession.

If each of those periods are comparable and we sit in an economic purgatory between one recession and another, it might be at least mildly comforting to think that the next recession could still be a year away. The economic expansion between 1933-1937 lasted 50 months and the expansion from 1975-1980 lasted 58.  Our current expansion is still only 39 months old.  Just a babe!  A full list of economic expansions can be found here.

Earnings Estimate Accuracy

Earnings season is set to pick up again starting next week, and it's an important season because earnings growth has begun to slow in recent quarters even as the market has risen.  Analysts are expecting S&P 500 earnings to rise to $103 this year from $97 last year.  

Below is a chart of analyst expectations for S&P 500 earnings vs. realized earnings.  (The gray line shows the evolution of what analysts are forecasting for year end earnings throughout the year.)  No surprise, analysts' mid year forecasts rarely end up being correct, but eyeballing the data, when earnings estimates are below their highest annual levels this late in the year, realized earnings typically end up disappointing early year estimates.

Historical Relationship of S&P 500 Earnings to GDP

The S&P 500 is up nearly 16% year to date, even though earnings are expected to grow 4-5% for the year.  If earnings grow by that much, the growth rate would be roughly in line with nominal GDP growth, which was up 3.9% y/y in the most recent quarter (real annualized GDP growth was only 1.3%).

Below is a long term chart of S&P 500 earnings compared to GDP.  Even though earnings are slightly more volatile than GDP, over the long term the growth of each has been about the same.  Recently S&P 500 earnings have grown faster than nominal GDP as the economy has had a V shaped recovery.  One might expect this circumstance to reverse, or at least temper itself going forward.