Wednesday, August 24, 2011

Words I found today

hectored - Talk to (someone) in a bullying way
churlish - Rude in a mean-spirited and surly way

Tuesday, August 23, 2011

SP500 Price, Value, ahhhh! The CNBC Talking Heads are going to make my brain explode

A Wall Street strategist once said that when he walks into a financial services firm and they have a television programmed to CNBC, it's the same as walking into a hospital and they have their TV programmed to General Hospital. That is, it's laughable that doctors would learn anything from General Hospital and thus, it's laughable that any one worth their salt in finance can learn anything from the talking heads on business television.

The past few weeks have seen large gyrations in the stock market. I have seen friends and colleagues, the same who haven't looked at their 401Ks since the last crisis, frantically trying to log in to their plans website. The heads on CNBC are running about with their hair on fire, trying to claim the crown of most-over-the-top. The more the heads screamed the more my friends tried logging into their account. The friends told me the websites to change their allocations were down for days. ( An ancillary point, is that besides doing the minimum to garner the company match and then only plugging those funds into the cheapest bond fund offered, is insane.)

My only investment besides cash since 2006 has been Gold. In December 2008 I invested a huge amount of my portfolio 15% to that class and have just let it run to almost 30% now. The thing is I should re-balance it but I don't want to just put the money in cash, so the market gyrations might provide a buying opportunity. So I opened up the spreadsheet and did some crunching of the numbers.

The first thing I do is go to S&P's website and download the earnings data. Then I try and estimate how good the analysts estimates are for reported earnings. So the analysts proclaim that reported earnings will be 95.67 for 2012, if you divide that by the BAA bond yield of 5.67% you get that the SP500 should be worth 1,660.94. At today's current price it 1,140 it would be a screaming buy. [This is a hybrid of the "Fed Model" and a Dividend Discount Model, basically the price of the index will equal the earnings divided by the discount rate. (I use earnings because companies do stock buybacks now instead of dividends because they are economically the same and there is a tax advantage buying back stock)]

However, what if the estimates are too rosy, corporate earnings look pretty high relative to GDP. With macroeconomic gyrations, we might go into a recession and earnings could plummet precipitously. In S&P's own spreadsheet earnings in 2008 were 14.88 after being 66.18 in 2007. If we take the average annual earnings over the past 10 years earnings have been about $52 per year. If we divide that by the BAA yield we get a fair value of 917.81, thus we are overvalued at current levels.

So which is it are we overvalued by 24.2% or are we undervalued by 45%. This is why economist will always be employed, that is, there is a lot of tea leave reading in the economic circles. So I include a different method altogether to gain some insight into momentum.

Basically, by looking at the 200 day exponential moving average (EMA) I can gain a look at how people feel about the current valuations. When the index drops below the EMA the standard deviation of each day's return elevates and not in a good way because of economic uncertainty. When you are above the EMA the standard deviation lowers and the returns are more positive. Basically, the method tries to see the confidence of the market makers. Unfortunately, we are about 11% below the EMA currently. So it is not a good time to buy based on momentum.

Now, if the market were to plunge even further down to levels closer to a 9 handle, I would definitely pare my gold holdings back to 15%, and bring up my equity exposure to 20%. So I wait for the fire sale.

Imagine if CNBC had a sane talking head who did a quick analysis like above and said "Meh, prices looked elevated. I took this opportunity to sell some of my holdings and will wait for the prices to drop. The further prices drop the more earnings I get. This is akin to waiting to buy a 60" LCD televisions set after the Super Bowl (when prices drop) versus buying a 50" set before." The important thing to remember is that you are buying earnings; you are not buying a lottery ticket when you purchase stock.

PS~ Alternatively, if the news picks up and the index pierces the EMA I would take a short time frame position in SPX, but not rotate out of my over-weighted gold allocation

The green arrows are when you would want to buy and the red arrows are the sells. Specifically, I would buy when I am in the range for what the index should be bought for and you pierce the 200 day EMA, and I would sell when the index seems too high in price to earnings and it blows through the EMA.

Friday, May 14, 2010

Greece viewed thru an American lens

Over the course of the past two months Greece has dominated the headlines. Even the comedians piled it on this weekend with "Really Greece - you're in crippling debt and you don't want to make spending cuts? Really? Where do you think your money is going to come from? Royalties for inventing civilization? Really? Your only exports are olive oil, takeout coffee cups, and Zach Galifinakis."

I could not really grasp how the country was such a hot mess. When asked by co-workers what the whole debacle was about I had a faint idea and feinted more than I knew. I knew Paul Krugman said they had a primary deficit. I merely nodded my head in agreement. Then headed off to the inter-tubes for some research.

Wikipedia states that a primary deficit is the pure deficit which is derived after deducting the interest payments component from the total deficit of any budget. Now I understand what the words mean but to a get a true understanding of I needed to dig into the data, play with it and return it back in my own words. However, there are two things at play with what comes next, a) I don't have as much access as I did in my graduate studies to robust data that would give me the information that Paul used to make his assertion and b) it would be far easier to look at the US data and it would be more meaningful to what I deem a US-centric audience.

I do not want to stray to far from the topic but this ancillary topic is important and probably deserves a post of its own. The deficit is the debt incurred in a single year and the national debt is all the debt accumulated over the past years that has not been paid off. When the debt comes due the Treasury, if there is not a surplus, will pay off the previous holders of the Treasury securities with new bond offerings. The cash received from the new offerings will pay the interest and principal on the old debt that is retiring. The structure of this debt is very important. As a country becomes increasingly risky it will find that it has to issue debt in shorter durations to achieve an acceptable funding rate because investors, here and abroad, will not want to take on a longer dated debt obligation due to the increasing risk of non-payment, i.e. default.

Here is a historical chart. If you have eagle eyes you can see that we have been in a surplus in 5 of the 40 years that the chart covers. This chart does come with a caveat that you are looking at nominal holdings and thus inflation would erode some of the levity that this chart imbues.

Above is the average maturity of the United States debt as it has evolved over time and how it projects in the future. The Treasury is taking advantage of the need for US Securities by bringing back the 30 year bond and extending the maturity so that there will be less likely of a situation where there is need for short term issuance to pay interest payments. This is where the US and Greece diverge. Greece has its two year debt pre-bailout trading anywhere from 12-20% payments based upon the principal you would pay to get the coupons. The US is faced with the opposite, our rates are so low that we are extending out the maturity schedule to take advantage of the historically low rates.

Is the difference only a temporal one? No, Greece also has a structural deficit besides the primary deficit highlighted above. So think back to the total deficit above and ignore the primary deficit. The structural deficit is the portion of the debt that always exists because of expenses undertaken that it must pay either voluntarily or at its discretion, think social security versus military spending. Another way to view the structural deficit is via the business cycle. For simplicity, we hypothesize that there are only two states boom or bust. In boom there is low unemployment and tax revenues are growing. In the bust it is the opposite there is a high unemployment and tax revenues are declining. In the second status the deficit will grow because the government will be paying out the same amount of services but revenues will be down, hopefully though, the government planned for the rainy day and used it surplus in the boom to not only keep up the same amount of services but also to extend services that will need expansion during a recession. The biggest expenditure that needs expansion is unemployment insurance.

Let us next look at the latest information.

What we are looking at here is the entire budget (revenues and expenses) encompassed in the large circle. By accounting convention the three pie pieces must equal. We have in order the Revenues in yellow, the expenses in blue and the deficit in red. The deficit must be balanced by borrowing in the capital market. The funding for the deficit is received form both US investors and those from abroad.

We break out the revenues by source to glean insight into how our federal government funds itself. The key categories are in order: income taxes (45%), social security and payroll tax (40%), corporation income tax (9%) and other (3%.) It becomes quite obvious that the taxpayer is the major supplier of all the revenues of the Federal government. What is quite amusing is that when viewed through a political lens one always hears about the gift tax or the estate tax. Now, both of those when added together equal 84 basis points of the Federal government's income or 0.84% for the lay person. Thus, anyone pontificating about that should explain why that particular issue is more pressing than payroll taxes or income taxes.

This chart is slightly different in that revenues and expenses are reversed. So it goes expenses in blue, revenues in yellow and deficit in red. There is continued color coding in the breakout. With the bright red being the mandatory spending in a particular year, the black being the interest paid out (mandatory,) and then the bright yellow being the discretionary spending. I'll just list the categories and spending percentages:

Social Security $695 19.57%
Medicare $453 12.75%
Medicaid $290 8.16%
Potential Disaster $11 0.31%
Other Mandatory Prog's $571 16.08%
Interest on Debt $164 4.62%
Defense $663.70 18.69%
Govt Svc Programs $704.10 19.82%

So the key for the US will be the mandatory programs (SS, Mc, Ma, PD, Other and Interest on Debt) versus the income received. Bluntly stated $2,380 income versus $2,184 mandatory expenditures.

Is there one easy cut in this list? Obviously, the interest on debt is above all others. SS, and the Medicare/Medicaid funds are a no-no. You cannot cut defense in a recession unless you wish the unemployment rate to increase further. However, there must be some fat in the Government Services programs; waste, fraud, incompetence, etc. Below is the department, the spending and the percentage of the total ($704.10.)

Health & Human Svcs $78.70 11.18%
Transportation $72.50 10.30%
Veterans Affairs $52.50 7.46%
State $51.70 7.34%
Housing $47.50 6.75%
Education $46.70 6.63%
Homeland $42.70 6.06%
Energy $26.30 3.74%
Agriculture $26.00 3.69%
Justice $23.90 3.39%
NASA $18.70 2.66%
Commerce $13.80 1.96%
Labor $13.30 1.89%
Treasury $13.30 1.89%
Interior $12.00 1.70%
EPA $10.50 1.49%
SSA $9.70 1.38%
NSF $7.00 0.99%
Corps of Eng $5.10 0.72%
NIB $5.00 0.71%
Ntl & Comm Svcs $1.10 0.16%
SBA $0.70 0.10%
GSA $0.60 0.09%
Other Agencies $19.80 2.81%
Other $105.00 14.91%

Here are some poll results from a YouGov/Economist poll of what and where to cut.

26. If government spending is reduced in order to balance the budget, which of the following government programs should receive lower federal funding than they currently do? (Please check all that apply.)

Social Security ..............................................................7%

National Defense ........................................................ 22%

Medicare ....................................................................... 7%

Aid to the Poor .............................................................17%

Medicaid ..................................................................... 11%

Veterans’ Benefits ........................................................6%

Health research ...........................................................13%

Education ................................................................... 12%

Highways ....................................................................12%

MassTransit ................................................................27%

Foreign Aid .................................................................71%

Unemployment benefits ............................................19%

Science and Technology ............................................22%

Agriculture ..................................................................27%

Housing ......................................................................27%

The Environment ........................................................29%

None of the above ......................................................12%

Maybe it's just a notion that Americans would like to keep all the government programs in place just not pay for them. A phrase Krugman called using Alabama's taxation policy to fund Connecticut's services. The problem is that the expenditures for Social Security, and Medicare and Medicaid are only projected to continue rising. Thus, the structural deficit will only continue to rise. Currently, we are just below the cut off point where the structural deficit is larger than the annual tax income. However, if maintained it plays out like a nationwide game of chicken. It seems that there is an inertia present to maintain the status quo until a disaster occurs and then, and only then, will the entrenched interests' lobbying power be set aside toward popular opinion. One only need look at Katrina, the financial reform act, the oil spill in the Gulf for recent, vivid examples of this terrible game being played out.

It is also the game that Greece must now play as they must make fiscal cuts as a percentage of GDP instead of just a percentage of government receipts just to balance the books.

The above graphs show that the United States is on a path towards what Greece is currently experiencing, however, Greece has arrived at its day of reckoning while the US only faces the prospects if those elected to power or rather those electing politicians to power do not begin to make the tough choices needed.

Sunday, November 1, 2009

Education Serial Malinvestment

I was reading a post from Mish the other day about education malinvestment and wondered if I could model it. But first let me re-post the letter that started Mish off.

When I attended law school at George Washington U in 1969, the tuition was $1,900 a semester. I worked my way through and had no debts when I began to practice law.
Later, student loans became the norm. The loans were subsidized, encouraging students to become indebted rather than build sweat equity in themselves. Student loans also took parents off the hook for saving to pay for their childrens’ education. The result was still more government dependency.

Screwing up the marketplace with subsidies, drove up the price of education, encouraged institutions to grow based on government support, and placed undue emphasis (economically) on higher and frequently useless education.
We should expect the higher education market to suffer a similar fate to the real estate market, where subsidies, encouraging people to buy what they could not afford (and did not need) led them to a result that, when compared to their investment in time and treasure, was uneconomical.
Eugene Holloway

It seems like a very logical argument, but then I wanted to check what the real price was by inflating via CPI, and also comparing median household income for college graduates in 1969 to today.

He said that it cost 1,900 per semester and the price level has risen 487.52% since them, so in terms today that is $9,262.88. This is 617 dollars per credit hour assuming a full time course load of 15 credits. In my last year in my MBA at a private university the tuition was 1,040 a credit hour so even controlling for inflation the price for a graduate education has risen faster than other prices. [The premium is 68.56%] However, this is only one side of the puzzle, we also need to see what the income level has risen to as well.

With an advance degree the Census shows that in 2000 earned 55,242. The historical data set is not great for tracking down incomes by levels of education. However, in 2000 the median household earned 41,990, so there is a 31.56% premium for the advanced degree. The data set only goes back to 1975 but keeping the same premium when the 1975 median income was 11,800 is $15,524 for an advanced degree. When we inflate the salary so as to make an apples to apples comparison we then find out that the 1975 graduate salary would be $51,705. So there has been an increase in return to attaining a higher degree, but the premium here is 6.84%.

The veil of prices is very tricky. It is easy to allow yourself to look at an old bill and then compare it to one today, but you have fooled yourself since prices of goods and services including most importantly the wage portion of services have increased over time. On this basis, people who have an advanced degree today are better off than those that gained one back in the early 1970s.

Master’s Degree Cost: 64 credits









After tax Monthly Income



Student Loan Cost



% of Monthly Income



As you can see it becomes a little gray as to whether it is a good choice or not. It is a high amount of your disposable income but I also assume that it is paid back in 15 years, whereas these loans can be strecthed to 30 and even 40 years in some cases. It also depends on your cynicism to decide if getting a good job is more like winning a lottery than merit and skills based.

However, this recession might not be the same as previous versions. Salaries might plummet due to the supply of willing labor that hunts for employment. It will be interesting to watch this unfold over the next few years to see if this cohort of graduate students did make a bad economic bargain by going into debt to gain further education.

One of the key teachings that I received during my MBA was from my grouchy advanced finance teacher, by advanced I mean he taught the investment course and the futures & options course. Basically, he called us all idiots. He said and I quote, you make a bargain and you go into debt. You have a certain amount of payments to make at certain times. That's fine. However, you have no idea what your income is going to be. You could have a high-flying job and then get laid off. You may never attain the MBA salary, but it does not matter you still have that debt. The debt does not care and you have to pay it each month. The key is to keep your debt as low as possible so that when fate invariably intervenes with your income statement you can still make those payments until better economic times come back.

On to the model.

Here is the basic supply and demand curve shown along the price and quantity axis.

The government hopes by subsidizing the student loan market, which is a noble cause because having a better educated workforce not only makes for a better electorate but also is one of the only way that advanced economies can continue growth, will increase the supply of schools offering education.


What we are seeing is an inducement for people to take on more education and the price rising. (This is not scaled at all, just showing the move.) So more students are getting degrees but Harvard can only hand out so many a year, thus, the cost must rise.

In truth what is happening is a little of both. Anectdotal evidence when I was obtaining my undergraduate degree at the University of Florida, the only "real" choices in the state was there or Florida State (that is if you did not get into Florida). Now, however, there are comparable educations offered at Central Florida, South Florida, there is a new university in Southwest Florida. So the state system has expanded to accept more students but prices have still risen. So the way I see it, I would model it like this...

How do I know this is correct? Here is the student population for each year of undergraduates and graduates.

You can see that even though prices have gone up by about roughly 60% the undergraduate population has grown by 238.36% and the population of the graduate students has risen 322.46%. Except for the total US population has grown over time as well, so we would need to control for that as well.

So the number belie Mr Holloway's argument and augment mine. Yes, prices have risen but the median salary for college educated workers has risen as well. The population is better off than it was before. The aggregate numbers of students has grown almost 3x as much the price difference meaning that higher learning schools are responding to the inducement to take on more students via financial aid, but it also shows that the demand is rising as well because of the government's program.

As I stated above and in other posts there are only a few "things" in an economy that can improve GDP and the standard of living for a country. For advanced countries there are even less because they will have already exhausted some of their natural resources and fully employed their labor. The last main way to better itself is through technology inlcuding the advancement of knowledge to have a better trained work force that is more productive.

While any program can invariably be run better; the Federal Student loan program has been a success on the whole for students have made use of it.

Thursday, October 29, 2009

I hope this is not affirmation bias...

This discussion follows up nicely with Rosenberg's piece from earlier.

Employment: Some slides

Brad DeLong with no commentary provides these slides on his website.