Friday, December 21, 2012

Happy Holidays! Offbeat Holiday Stats

Dear Readers,

I wanted to thank everyone who reads this blog for their interest.  I love investing and it's fun to write these posts, but it means a lot to me that there are others out there who are enjoying the content that I've been putting together.  The blog will be in hiatus until the New Year (that's the plan at least, but I'll be around next week so there is always the possibility of a post).  I look forward to starting back in 2013 with more analysis that I hope you all will enjoy.  In the meantime I put together a list of holiday stats to entertain.  Happy holidays!

Scott Krisiloff

Holiday Statistics


· Americans eat 68 million Turkeys on Thanksgiving and Christmas (that’s 31% of the annual total)

· The average Turkey weighs 16 pounds, meaning that over 1 Billion pounds of Turkey are consumed on those days—roughly 3 pounds per capita.


· A menorah burns 44 candles over the course of 8 nights of Hanukkah

· An average candle generates 250 BTUs (British Thermal Units) of energy, which means that a menorah generates 11,000 BTUs in 8 nights. That’s about equal to 0.18% of a barrel of oil.

· There are 2.9 million Jewish Households in the US. If each household lit a menorah every night of Hanukkah, the total energy content of the combined candles would represent about ~5,500 barrels of oil, enough to last a population of 10,000 Maccabees for 8 days (assuming that the Maccabees drive SUVs and otherwise consume oil at US per capita rates).


· 95% of Americans say they celebrate Christmas. 93% exchange gifts and get together with family. 88% put up a Christmas tree.

· Only 76% of Americans describe themselves as Christian, which implies that ~80% of non-Christian Americans celebrate Christmas.

· There are roughly 50 million kids age 0-11 in the US. If Santa spends $75 per child he would spend $3.75B on presents per year. If Bill Gates decided he wanted to be Santa Claus, his fortune would last for ~16 years at that pace.

New Year’s

· ~30% of all champagne sales take place in the last 2 weeks of the year. That’s ~300 million glasses or 1.25 glasses per working age US population.


Thursday, December 20, 2012

How Often is the Dow Negative in May?

I may be getting a little ahead of myself here, but since the Santa Claus rally has been in full effect in 2012, I'm starting to think about the next time that the markets will hit a seasonal turning point.  The next big seasonal mile marker is when we are supposed to "sell in May and go away" 5 months from now.

In the recent past following the adage has been pretty effective.  The Dow has been down 3 years in a row in May, and 4 of the last 5.  In fact, even in 2009 when the market was rallying from the depths of the bear market, the index did take a breather around May.

The fact that seasonality has held so well in May got me to thinking about how and when the streak could end.  After all, in the 113 year history of the Dow, May is only negative a little over 50% of the time.  So will 2013 be a year to shirk seasonality?

Below is a chart that can perhaps help provide some guidance.  It shows the length of Dow losing streaks in May.  There have been three times that the Dow was negative in May for more than 3 years in a row.  The longest streak was between 1965 and 1971 when it was negative 7 years in a row.

Wednesday, December 19, 2012

Critique of Monetary Realism

I've recently been fairly active on the message boards at Pragmatic Capitalism, which is a great site put together by the very talented Cullen Roche.  The folks at Pragcap subscribe to a theory of money called "Monetary Realism," which you can read more about at their site.  

Typically I try to only explicitly and actively voice my opinion on my site through my monthly investment letters; however monetary philosophy is something that I think is crucial to understanding the investment environment, and I've generated a lot of content at Pragcap which I think is important to share with my readers here.  

The basic framework of monetary realism is that the monetary system consists of "inside money" issued by private banks as deposits and "outside money" issued by central banks as currency and reserves.  The philosophy contends that a private banking oligopoly is outsourced the right to create money by the US government.  "Outside money" is only in existence to facilitate the clearing of transactions made with "inside money."

I disagree with parts of the philosophy, I agree with other parts of it, but my main frustration lies in how it defines its terms and the narrow prism through which it attempts to describe the monetary system.   It arbitrarily draws lines where they don't need to be, and my sense is that the bulk of that is because of disagreements with a predecessor theory called MMT, which has its own shortcomings.  Below is a comment which I posted this evening that sums up my important criticisms of the framework.  Presented un-edited:

(in response to a previous comment)

After thinking some more about the issue of non-banks creating inside money I am willing to acknowledge that I am wrong to say that anyone has the ability to create “inside money” as MR defines it. In trying to incorporate MR’s framework and definitions into my framework for looking at savings markets, I erred and do see that banks are the only entity that can create deposits. We are now 100% in agreement on this point. Deposits are the sole domain of the commercial banking system. This explains why deposits are created when a bank buys a security but not when a non-bank individual buys a security.

The reason that I said that non-corporate entities could contribute inside money was based on my intuition that there is clearly net financial value created outside of the banking system in securities markets, which can be converted to deposits. If I buy an equity security which appreciates in value, net value is being added to society. If a company issues a corporate bond, a net savings product is being added to society. In attempting to draw a link between deposits and securities as a savings mechanism I do concede that I overextended the ability of securities markets to unilaterally effect the banking system.

However, this does not change the fact that I continue to believe that the MR framework is incomplete as a description of the modern monetary system because of the lack of incorporation of the bulk of the way that modern households do store their wealth. Empirically deposits are not the primary way that Americans save. In order to spend savings it is true that a crucial step is to clear through bank deposit markets. However, this clearing step should hold no more significance to aggregate economic purchasing power than the interbank clearing process via what MR refers to as “outside money.” Both are facilitating transactions based on purchasing power that is not dictated by the quantity of deposits held within the commercial banking sector.

To the extent that a monetary framework should describe the aggregate purchasing power and savings of a society, a truly modern paradigm for the US must include the securities markets as a centerpiece. As of March 2012 an average American household holds 15% of their financial assets as deposits. Any attempt to describe the liquid purchasing power of American households must include the other 85% of their financial holdings, which can easily be converted to bank deposits.

At the other end of the money spectrum lies USD. What is USD? I will continue to contend that the US dollar is the sole domain of the US government and that quantity in circulation does not matter only that it does have a specific value. It is a yardstick of economic value. There doesn’t need to be enough yardsticks to measure everything in the world to define what a yard is. The yard is a clearly defined unit of measurement endorsed by a) the government, but more importantly by b) the people and convention. The USD is no different, and derives its direct value from the quantity of the liabilities on the Fed’s balance sheet relative to the value of the assets on that balance sheet. This is no different from a foot deriving its base from a monarch’s forearm. A foot is “backed” by the length of the king’s forearm. Importantly although the size of the monarch’s forearm may change from monarch to monarch and the numerical value of feet from my couch to my door may change, there is nothing that the unit of measurement can do to change the real physical distance that I observe.

So where do deposits fit in this framework? They are a specific type of security which has a value generally equal to 1 USD. They are backed by the assets of the issuing bank ALONE, and their value cannot exceed 1 USD, even if their uninsured value can be less than 1 USD. (Just ask uninsured depositors of Indymac bank).

Deposits are a type of security. USD is a type of security. Corporate Bonds are a type of security. Equities are a type of security. All have an issuer and a holder. None is “ruler” of any other. All are means of saving. All have tradable value in relation to each other. All are “money” in some sense. Only one is USD.

Tuesday, December 18, 2012

2011 Dogs of The Dow Performance in 2012

With the year winding down and Bank of America up nearly 100% for the year on today's move, I thought it might be a good time to revisit how all of last year's Dogs of the Dow have done in 2012.  Thanks to Bank of America's huge gain the 10 worst performing stocks of 2011 have averaged a 10.5% return in 2012, 2.2% better than the rest of the Dow.  However, if you strip out BAC's gain the performance is less than stellar.  On average the other 9 stocks have returned only 1.3% this year.

Dogs of the Dow Performance 2012

Monday, December 17, 2012

What Does it Say That Samsung and Apple Have Roughly the Same Multiple?

It seems interesting that according to data pulled from Bloomberg's site Apple and Samsung are trading at virtually the same earnings multiple.  One would think that if Apple is losing share to Samsung then Samsung would have a higher multiple.  Samsung has been advancing as Apple has declined, but given the low multiples across large cap tech, does Apple's decline say more about the company or the industry?

Friday, December 14, 2012

How Long Can Real Interest Rates Remain Negative?

Ray Dalio made some news this week when he acknowledged that interest rates had probably gone about as low as they could possibly go and that the next big opportunity will be shorting the bond market.  I'm inclined to agree, but there is some historical precedent for rates to go lower and stay there for even longer.

Dalio argued that real rates are currently negative (nominal rate minus inflation)--which they are--but they were also negative for 10 years between 1936 and 1946 as shown by the chart below, which compares Moody's average Aaa bond yield to the realized 10 year forward inflation rate.  Inflation was high during this period, reaching above 10% in some years thanks to WWII.  The fact that rates stayed low is a testament to the fact that it's not a good decision to try to fight the Fed.

Real Interest Rates Negative World War II
Used Aaa bonds as proxy for risk free rate.  Source: Federal Reserve Data

Thursday, December 13, 2012

Why the Monetary Base Matters

Below is a comparison of the monetary base and CPI since 1918.  Each series has been indexed so that the value is 100 starting in 1918.  The data is also presented in logarithmic scale so that it's easier to interpret rate of change.  I'll admit there's not a lot of science involved in this analysis, but eyeballing the chart it's fairly clear that inflation and monetary base growth are highly correlated.  Although the series diverge in the late depression/WWII era, they generally exhibit a similar pattern with a slightly lagged increase in CPI following an increase in the base.

If the two series are re-indexed to 100 in 1945, the relationship is even more clear.  Between 1945 and 1983 CPI increases at almost the exact same pace as the monetary base.  In January 1983, when the two series diverge, the CPI calculation was adjusted to substitute a survey of "owner's equivalent rent" for housing prices.  Further adjustments were made under the Clinton administration which slow the pace of CPI growth.

Since 2008 we are seeing another divergence in the relationship between CPI and the monetary base, but as I've noted in other posts, the relationship of the monetary base to oil and gold remains extremely strong, which is consistent with the idea that when more money is printed it becomes less valuable.  It is likely that a commensurate increase in CPI will occur at some point.

Annual Change in Monetary Base Since 1918

After yesterday's post forecasting that we could see a 40% y/y increase in the monetary base in 2013, I thought it might be good to look at a long term chart of the monetary base to put that number into context.  Below is a chart showing the rolling y/y increase in the monetary base since 1918.  The only other time there has been such a steep increase in the US base was during the depression/WWII era during which there were three different periods of 20% annual growth in the base.

Wednesday, December 12, 2012

How Fast Should We Expect Unemployment to Decline?

To go along with the previous post forecasting when a 6.5% unemployment rate could occur, below is some analysis on how fast unemployment typically drops when we are in a period of falling unemployment.  Since 1949 there have been 10 periods of falling unemployment.  On average the unemployment rate falls by about 7 bps per month when it is declining.

Although the "scariest jobs chart ever" which has made the rounds on the internet implies that unemployment is falling at a much slower pace than it has in past cycles, in reality, we're basically in line with the average rate of decline (the unemployment rate just spiked from a lower base than it had in the past.)

Unemployment Rate of Decline

When Will Unemployment Hit 6.5%?

As part of today's statement, the Fed acknowledged that it would be maintaining the current QE rate until unemployment hits 6.5% or inflation gets out of hand (paraphrase).  Below is an estimate of when unemployment could hit that level based on an extrapolation of the current pace of decline.  Since peaking in late 2009 at 10%, the unemployment rate has fallen on average at about 6 basis points per month (.06%).  If it continues at this pace, the unemployment rate would hit 6.5% in mid 2014.

[Note that the decline has not materially picked up much pace in 2012.  In 2012 the rate declined by an average of 7bps per month.  At this pace 6.5% would occur just a few months earlier in 2014.]

Unemployment Forecast

Forecast of Monetary Base Through 2014

Well, it's official.  As was widely expected, the Fed announced today that it would increase the size of QE to $85B per month from $40B per month.  Below is an updated forecast of what the US monetary base could look like to start 2015 if QE lasts that long (for the record, my money says it wont).  At its peak growth rate, the base will increase by ~40% y/y.  Under the previously announced program the base was slated to grow by a robust 17%.  By 2015 the monetary base could be nearly 6x the size it was in 2008.

Tuesday, December 11, 2012

What Happens If Congress Refuses to Pass a Fiscal Cliff Deal?

I've recently heard a few people talk about how congress wouldn't fool around with a fiscal cliff vote because it learned its lesson after it failed to pass TARP, which caused the market to fall apart.  While it may be true that congress is still scared from 2008, it's not entirely true that securities markets fell apart after the first TARP vote failed.  In actuality neither the Lehman bankruptcy nor the failed TARP vote precipitated the bulk of 2008's equity market collapse.  Counter to the historical narrative, the real crash came after TARP was passed.

Lehman announced its bankruptcy on Sunday September 14th and the market was actually up slightly the following week on rumors of TARP.  When congress initially refused to pass TARP, the Dow did fall by 777 points on the day, but recovered more than half of those losses the next day.  In fact, the S&P 500 was down less than 10% from the beginning of September until TARP was passed.  

The market crash began in earnest the day that congress passed TARP.  Between that day, October 3rd, and the 2008 low on November 21, the S&P fell 36%.  After a 20% rally into December, it would continue falling until March of 2009.

Is Tax Selling Causing Apple's Decline?

In recent weeks, there has been talk that part of Apple's 23% decline may be due to the fact that capital gains taxes are likely to go up in 2013.  The logic goes that since many Apple shareholders are sitting on large capital gains, they are selling to lock in a lower tax rate.  If that logic were true one would expect to see similar selling in other top performing stocks, but on average other top long term holds have not seen the same decline that Apple has.

In October I posted a list of the top performing stocks since October 2007--stocks which should have large embedded capital gains liabilities.  The chart below compares their performance since the election.  It turns out that on average these stocks have continued to do better than the S&P 500 since November 6.  This basket has outperformed the S&P by 2.8% since then.

Capital Gains Effect on Stock Selling

Monday, December 10, 2012

What Happens To Japanese Government Interest Expense if Rates Rise?

Recently there has been more talk that the Bank of Japan would increase its asset purchases again in order to create inflation there.  Given the high level of government debt in Japan, increasing inflation and rising interest rates could cause some unique problems.  In particular, rising rates would mean rising interest expense for the Japanese central government.

Currently the government spends about ¥9.8T on interest expense, which works out to about 1.23% on ~¥800T in aggregate debt.  At that level of debt, every 1% increase in the government's interest rate means another ¥8T in expense.  This implies that at a 5.2% average rate, interest expense would exceed current receipts of ¥42T.

Japan Government Debt

It's important to note that this analysis doesn't take into account the tenor of the current debt load.  Since ¥440T has a maturity of 10+ years it would take some time for interest expense to match any increase in market rates.  I also haven't modeled in any changes in the aggregate debt load.

Thursday, December 6, 2012

December 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.

Dear Investors,

November was the wildest month for equity markets since…last November. The S&P 500 was down as much as 5% mid-month, but managed to finish slightly positive thanks to a late month rally. One might recall that this is nearly identical to the trading pattern of November 2011, when the S&P 500 was down by 7.5% mid month, but finished down only slightly. That reversal was the beginning of a five-month-20%-rally for stocks. Let’s hope that the pattern continues to hold.

Certainly there are plenty of reasons why we shouldn't have a repeat of last year though: the fiscal cliff hangs over the market, earnings growth has been slowing, Europe is still unresolved and China has lost some of its shine. But there was lots of gloom this time last year too, and that didn't impede a big rally. As I've written before, one of the only things I can guarantee investors is that the market will swing between times of extreme optimism and extreme pessimism. Counterintuitively, pessimism is actually what tends to propel the market higher, because when people become so focused on what’s wrong with the world it creates an opportunity for known problems to be solved rather than new problems created.

Right now the problem that everyone is focused on is the fiscal cliff. For most of the year I have focused on this problem as well, but after further analysis I’m glad to write that I think the cliff could be more manageable than the market currently expects. Ultimately the cliff itself is a bit of a red herring because the alternative to the cliff is a compromise, which means higher taxes and lower spending (just like the cliff). Either way there is going to be deficit reduction in 2013. This is “bad” to the extent that it means a removal of short term stimulus, but in the “worst” case circumstance the deficit would be reduced by about $45B per month, which is almost exactly the same amount of money that the Fed will be providing to the economy via QE3. The Fed is doing everything it can to create a monetary cushion to land on in the event that we hurl ourselves over the cliff. In the short term, I think there is a good chance that it could work.

Two caveats: 1) there is a strong possibility that going over the cliff could be so damaging to market psychology that it won’t matter that the alternative wouldn't have been much different. 2) What’s good for the short term is not necessarily good for the long term. Deficits boost the economy today, but both fiscal and monetary stimulus must be reduced at some point. The US economy cannot exist in a state of perpetual economic stimulus, and the true cliff will come when congress addresses entitlements and the Fed stops printing money. Those ideas aren't even currently part of the national dialogue, which is far from positive. The “good” news is that for now market participants will likely continue to ignore the elephant in the room and bid securities prices higher. The bad news is that the more we ignore it, the bigger the elephant will be when we are finally forced to deal with it. Alas, all this is for another day.

In terms of our portfolios, I’m happy with how we are navigating this period. In the middle of last month, we reinvested a sizable portion of our cash position and were able to benefit from the pullback by buying some really good companies at favorable prices. As long as we continue to do this, I feel confident that we can continue to do well in a variety of investment environments.

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.

Non Performing Loans at US Banks

Despite concerns about the fiscal cliff, it should be encouraging to investors that bank stocks have held up quite well over the last couple of months.  It seems that sentiment may have finally turned for the group, especially for Bank of America, which regained the $10 level yesterday yet still trades for a little over 50% of book value.

The banking system has healed a lot since 2008 and profitability has almost returned to old highs.  However, non-performing loans remain piled on US banks' books and probably will stay there for years to come.  According to recent FDIC data, non performing loans (NPL) as a percentage of all loans at FDIC insured banks are still higher than they were at the peak of the S&L crisis.  

While it's an interesting data-point, this isn't necessarily cause for alarm because NPLs are supposed to be written down to fair value when they go to non-accrual status.  This means that as long as housing prices remain stable, these loans probably wont have to be written down any more.  Also, just because a loan is marked as NPL doesn't mean that it's not still paying.  In fact, many of these loans are probably still generating cash flow for the banks that hold them.

Non Performing Loans

Wednesday, December 5, 2012

After an Iconic CEO Leaves

Since Apple is having a particularly rough day today, I thought it would be worth reposting something I initially posted in August 2011 when Steve Jobs officially stepped down as CEO.  It's a comparison of DIS, WMT and MSFT after their iconic CEOs departed.  Looking at DIS and WMT, each of those companies continued to be top stocks for 5-6 more years.  MSFT underperformed the S&P but greatly outperformed the Nasdaq after Gates left.  Can AAPL's outperformance last as long?  It's gone about a year and a quarter without Jobs and until recently has remained a strong stock, but perhaps tech is such a rapidly changing space that the benefit of Jobs' vision has less longevity.


Originally posted 8/25/11:

With Steve Jobs stepping down at Apple, there are plenty of questions about what comes next.  Jobs is undisputedly the most influential CEO of the last decade and one of the most influential people of the last 35 years.  Jobs' contributions to society have been extraordinary and today he is deservedly drawing comparisons to other great industrialists like Ford, Edison, Carnegie and Rockefeller.  When the history books are written, it's likely that these comparisons will hold up.

While I wanted to run a stock chart comparison to these early 19th century industrialists, individual stock data from the early 20th century isn't easy to come by.  Still, there are at least three iconic CEOs of the latter 20th century who can arguably be compared to Jobs: Disney, Walton and Gates.  Here's a look at how each company's stock performed in the decade following its CEO's departure.

Each chart begins on the date that the CEO stepped down.


Click to Enlarge



What's striking is that in the case of DIS and WMT, each stock continued to massively outperform the S&P 500 for 6 and 5 years respectively after the departure Disney and Walton.  Perhaps this is a testament to the bench of talent that a great CEO cultivates.  However, after the 5-6 year mark, both stocks had prolonged periods of underperformance (for DIS at least partially due to the 1974 bear market).  This may be an indication that a visionary CEO can continue to carry a company for years after leaving, but after a while, the company loses the benefit of that vision.

Of the three companies, only MSFT has underperformed the S&P 500 from the day that Gates stepped down.  Of course at least part of this has been because of the collapse of the tech bubble (MSFT was trading at about 60x earnings at the time).  Still, looking at the underlying earnings of MSFT and the gross mismanagement since Gates left, it is a testament to Gates' leadership that the company continues to enjoy top market share in the PC business.  

Another primary reason for MSFT's poor performance has been because of the efforts of Jobs himself who arguably engineered an organic monopoly in high end consumer electronics.   He will be missed for his vision, but we may not really know how much we miss him for another 5 years.

Tuesday, December 4, 2012

Corporate Bond Issuance Since 1996

With interest rates at record lows and possible tax changes on the horizon, a number of companies have been accessing corporate debt markets and using the proceeds to alter their cap structure.  Today, Intel was the latest company to announce a debt offering to repurchase shares after that stock has fallen more than 30% since May.

One of the goals of maintaining a zero interest rate environment is to encourage consumers and companies to take actions like this.  The Fed is trying to push the economy to re-lever.  So far, it has had mixed success in this pursuit, although borrowing has begun to pick back up in 2012.

As far as corporate debt securities go, 2012 could be a strong year.  US companies are on pace to issue $1.3T in new debt into securities markets (through October).  This would be a new all time high and is already more than was sold in all of 2011.  As a percentage of corporate bonds outstanding though, that number is still lower than in the late 90s--only 16% vs over 25% back then.  It's almost double what was issued in 2008 when credit markets froze though.

Bond Issuance per Year
Source: SIFMA

Monday, December 3, 2012

US Auto Sales

US auto sales continue to rise in recent months, which is causing a fair amount of excitement about the possibility of a hot auto market.  High ticket items like cars can be big contributors to GDP, so from an economic standpoint the data is very encouraging.

Still, from a historical standpoint, auto sales remain relatively weak.  If 15m vehicles were sold (annualized) in November, the rate is still below the average rate during the mid 2000's when there were closer to 17m cars sold per year.  

On a per capita basis, the number looks even more depressed.  As of October we were selling 0.047 cars per person per year in the US (~1 car for every 21 people).  Outside of this recession, you'd have to go back to the lowest point of the 1991 recession to find a similar per capita rate.

US Auto Sales