Tag Archives: S&P

U.S. stock prices continued their upward climb through the months of February and March, and the near 30 per cent gain in just five months has seen the major indices move above the levels that prevailed just weeks before the world’s capital markets descended into freefall during the autumn of 2008.

All too predictably, the sharp reversal in the equity market’s fortunes has prompted the perma-bulls to confidently declare that the path of least resistance is up.  There has rarely been a better time to buy stocks, they argue, given valuations that have seldom offered such high returns relative to Treasury bonds.  Could the soothsayers be right or is this just one more opportunity to lighten equity allocations in the face of the negative secular trend that has persisted for more than a decade?

It must be stressed that strategic allocation to equities should be consistent with the output of a properly-constructed valuation model that provides a relatively reliable estimate of potential future returns.  In this regard, it is unfortunate to observe that the industry appears to have learned little from the near-zero real returns earned from stocks over the past fourteen years, a disappointing outcome that stemmed in large part from overinflated valuations.

Indeed, far too many professionals continue to employ the very same techniques that failed to preserve capital so spectacularly through the two brutal market setbacks endured since the turn of the new millennium.  The inability to spot trouble ahead is typically blamed on unforeseeable events but, the plain truth of the matter is that reliable measures of valuation were pointing to meagre long-term return potential well before the markets completely exposed the industry-preferred methods that lacked theoretical substance.

The price/earnings multiple is the most widely employed valuation tool, but the standard calculation is deeply flawed given the use of single-point forward-looking projections of operating profits per share.  The denominator should reflect the market’s long-term earnings power and not a number that is unduly influenced by the stage of the business cycle.

In this regard, it is simply not reasonable to use an earnings estimate that incorporates profit margins that are at a multi-decade high, as is the case today, since the historical record demonstrates that this measure of profitability is one of the most mean-reverting of all corporate fundamentals.

Further, the traditional analysis calculates earnings before once-off items such as discontinued operations, extraordinary items, and the cumulative effect of accounting changes.  A top-down perspective suggests this practice is dubious, since asset write-downs and once-off charges are neither exceptional nor extraordinary in an economy-wide context, but an inevitable product of competitive rivalries, not to mention the ups and downs of the economic cycle.

The historical record since Standard & Poor’s first began compiling operating earnings data reveals that the level of once-off charges moves in tandem with the economic cycle.  Indeed, reported profits i.e. after write-offs, have moved to as high as 98 per cent of operating earnings during the past two economic expansions, only to drop to as little as 16 per cent during the subsequent downturn.  Simply put, bad investment decisions that seemed sensible during the boom are exposed during the bust that follows.

Those of a bottom-up persuasion argue that reported profits do not represent an accurate picture of a company’s ongoing earnings power, because the write-off truly is a once-off event.  However, if this argument had merit whereby one-off events are random, then one would reasonably expect the odds of a negative charge to be equal to the chance of a one-off gain.

The historical evidence however, paints a completely different picture.  In fact, there has only been eight quarters over the past 24 years in which reported profits have been greater than operating earnings, and only one quarter since the first three months of 1995.  Further, the gap between the two earnings measures has grown through time as the level of write-offs has increased at more rapid clip than operating profits.  Needless to say, the operating number is not a true and fair representation of the market’s long-term earnings power and should be discarded.

The price/earnings multiple popularised by Robert Shiller of Yale, uses ten-year average earnings as the denominator, and the historical data demonstrate that it has considerable predictive ability.  The current reading is close to 23 times, a level that has always been followed by lacklustre long-term real returns.  Indeed, investors could consider themselves fortunate if they go on to earn real returns of anything more than three per cent per annum over the next ten years given current valuations.

For those who doubt the message emanating from the Shiller price/earnings model, consider Tobin’s Q-ratio, which measures the market value of equity relative to its replacement cost.  The stock market is currently trading at more than 20 per cent above the long-term average, and as with Shiller’s measure, this technique suggests that investors can reasonably expect low real annual returns in the decade ahead.

The favourable stock market outlook espoused by the bulls is based not only on dubious absolute valuations, but also on the attractive yields relative to Treasury bonds.  However, several academics and practitioners have shown the comparison to be a form of money illusion with no ability to predict long-term stock returns.

The bulls are back in charge, but studied analysis shows their valuation arguments to be flawed and even dangerous.  As the late Humphrey Bancroft Neill, author of the 1954 classic, ‘The Art of Contrary Thinking’ observed “The crowd rides the trend and never gets off until it’s bumped off.”  Investors would do well to remember that it wasn’t raining when Noah built the Ark.

Previously posted on www.charliefell.com

 

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

The world watched European leaders last week take the next step toward saving the euro, a move that sparked some optimism from bank officials. In the U.S., jobless claims fell to new lows, and confidence abounded from Wall Street women about alternative investments.

Applause sounded after leaders at the European Summit agreed to sign an intergovernmental treaty to enforce stricter fiscal standards in their future budgets. Efforts to get all 27 members of the European Union (EU) failed as Britain and Hungary opted out. Importantly, the 17 euro zone members agreed to the new treaty, a welcoming sign to the European Central Bank (ECB) that said the treaty would be the basis of good financial discipline moving forward. Before the summit, Standard and Poor’s warned of possible credit downgrades of 15 euro zone nations, preparing to place those nations—including the powerhouse of Germany—on credit watch negative. This action normally signals a downgrade within three months. According to S&P, the action was “prompted by [its] belief that systemic stresses in the eurozone have risen in recent weeks to the extent that they now put downward pressure on the credit standing of the eurozone as a whole.”

Also in Europe, Greece readied its next step for its bailout. Inspectors for the country’s international lenders and private credits are meeting and preparing for a new 130-billion euro bailout plan and bond swap to keep the country’s economy alive. The EU, International Monetary Fund (IMF) and the ECB—known as the troika—are visiting Athens to start preparing the bailout plan agreed in October as well as assessing the impact of debt swap plan on banks. Earlier last week, Greece approved its 2012 austerity budget as it tried to cut its debt and pull itself out of recession. Responding to the measures, many Greek youths protested, hurling stones, bottles and firebombs at police. The country’s fiscal package included some very tough cuts that will unfortunately keep many Greeks feeling cash strapped. While Greece’s fiscal matters proceeded, Hungary sought a 10-to-15 million euro package from the IMF and EU to help stabilize its economy. The country asked for assistance after its forint currency hit record weakness because of market skepticism about the government’s unconventional policies.

In the U.S., new jobless claims fell to a nine-month low, showing signs that the job market may be improving. The Labor Department said weekly applications declined by 23,000 to 381,000. Some more good news came from women on Wall Street as they planned to seek alternative investments. Nearly 65 percent of the women surveyed said they expected to find attractive investment opportunities, according to a study by the professional services firm Rothstein Kass and the international women’s group 85 Broads. More than half of the women said they planned to start new funds too.

 

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Mirror, mirror on the wall, what’s the fairest currency of them all? The Brothers Grimm in “Snow White” posed that question about the queen’s beauty, but in the financial world, Germany’s Deutsche mark had been one of the strongest and handsomest monetary units in the land.

As the euro zone crisis continues, German Chancellor Angela Merkel and French President Nicolas Sarkozy have issued an ultimatum to the 27 European Union governments, saying they need greater control of their national budgets by Dec. 9. If countries don’t participate, the 17-member euro zone will progress with plans for amendments to fiscal treaties aimed at creating a tighter and more integrated union. While Germany spearheads reforms, Standard & Poor’s warned that credit ratings for European nations, including Europe’s economic powerhouse of Germany, could drastically fall if agreements to the financial crisis aren’t reached.

A history dating back to 1871, the Deutsche mark’s official user is Germany, with unofficial users Bosnia, Montenegro and Kosovo. This is our fifth post in our series about “currency culture,” where we examine the history of different world currencies and how they play a role in popular culture (see our previous posts about Britain’s pound sterling, Italy’s lira, Switzerland’s franc and Greece’s drachma). With an introduction as melodic as Ludwig van Beethoven’s Symphony No. 9, here are some interesting facts about the mark:

  • Commonly called the “Deutschmark” in English; called the “Mark” or “D-Mark” in German
  • Introduced June 20, 1948, by Ludwig Erhard, late chancellor of Germany, and replaced the Reichsmark
  • Symboled as “DM”
  • Banknotes of DM 5, DM 10, DM 20, DM 50, DM 100, DM 200; coins of 1 pf, 2 pf, 5 pf, 10 pf, 50 pf, DM 1, DM 2, DM 5, DM 10
  • Deutsche Bundesbank, the central bank of Germany, is referred to as “Buba” (from Budesbank)
  • Banknotes observe notable Germans such as fablers Jacob Grimm and Wilhelm Grimm, writer and novelist Bettina von Arnim, scientist Paul Ehrlich, naturalist Maria Sibylla Merian and mathematician Johann Carl Friedrich Gauss
  • Construction costs of Neuschwanstein Castle—the inspiration for Disneyland’s Sleeping Beauty Castle—during the lifetime of King Ludwig II totaled 6.2 billion deutsche marks
  • Signal Iduna Park, considered to be the “Opera House of German Football,” has an estimated price tag of 35 million deutsche marks
  • Deutsche Bank is a leading global investment bank in Germany, Europe, North America and Asia and title sponsors the professional golf tournament Deutsche Bank Championship held Labor Day weekend in Norton, Mass.
  • Taxi fare from Berlin Schoenefeld International Airport to the city of Berlin costs about 60 to 70 deutsche marks
  • Costs zero deutsche marks to enter Oktoberfest, the most famous event in Germany and the world’s largest fair (the beer, however, is not free)

Like a Mercedes-Benz, we hope these facts “mark” some new luxurious currency knowledge as your drive to master the financial markets continue.

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

1 Comment

The S&P 500 broke down below its August lows on Monday. That was something a lot of folks were not expecting to happen (including some in my own office). As such, it begs the question of how far the market may yet go, especially with all the talk now about how it's officially reached bear market status based on a 20% decline from the most recent highs. This also ties in with the dollar given the negative correlation between the two markets. So with that in mind, let's take a look at a couple of potential indications of what may yet be to come.

First we have the weekly S&P 500 chart. It could be said that the consolidation we saw following the August lows which saw the index move around in about a 1120-1120 primary range was the building of a bear flag pattern. If we go along with that then Monday saw the expected trend continuation on the new lows, meaning we should be able to derive a basic target based on the height of the flag poll. The first red box on the chart encompasses the poll. The second one plots that area from Thursday's peak to provide a conservative projection of about 970 for the index.

It's worth noting that the 2010 market low is not far away from where the flag projection comes in. That gives us a pretty good expectation for support to develop in the general zone around about 1000.

For me the important leading indicator is the German DAX, which has already taken out its 2010 lows. The sovereign crisis over there is obviously a major motivator in the selling seen thus far. It's been interesting to observe, however, that the DAX has not made new lows in line with those of the S&P 500 in most recent trading. The German market successfully tested support just below 5100 a couple weeks ago and hasn't re-challenged that level on the latest downturn yet.

Significant in chart the above is the volume pattern of late. Notice how the volume has not been as strong on the down days as much as was the case earlier in the move. At the same time, there's been some uptick in volume on the positive days. If that pattern holds and we see the DAX form a bottom here it would be a very good development for the global markets, and likely a negative for the dollar.

Note in the daily EUR/USD chart how the DAX actually led the euro lower by starting to break down late in August. Could it also be leading by potentially putting in a bottom?

The DAX bottom obviously works against the S&P reaching the bear flag target, but I'm not sweating that. My suspicion from looking at the monthly chart is that the market is due for a bounce in that timeframe, one which could rally the index back into the 1200s. Beyond that though would be a challenge based on the current situation. The sell-off from the year's highs has been very aggressive, which bespeaks a weak market.

I think the best case scenario for stocks is a consolidation centered on about the 1200 level as we see the volatility come down, narrowing the monthly Bollinger Bands in preparation for the next meaningful trend move. That's looking well down the line, though. In the nearer term, watch to see if the DAX holds its bottom. If it does, stocks will probably post a decent rally, putting the dollar under pressure as the "risk-off" trade is unwound.

3 Comments

The Forex market gets a bad rap in the media and other segments of the financial markets for being risky. It’s not a deserved reputation. In fact, the volatility of currency exchange rates is markedly lower than that of most other markets.

Not surprisingly, in the five year period ending December 2010 the fixed income market represented by 2yr and 10yr Treasury Notes was the least volatile. The major US dollar exchange rates make up the next lowest volatility group. After that come the major stock indices, with small cap stocks (Russell) unsurprisingly more volatile than big cap ones (S&P 500). Oil has been comparably volatile to individual stocks, which have demonstrated the most volatility.

Clearly Forex is no more risky than other markets, and in most cases can be described as less so. In other words, when the media and others portray the foreign exchange market as highly risky they do so on a really faulty basis because the volatility readings just don’t support it. Relatively low volatility, though, does not mean there aren’t any real opportunities to profit in the foreign exchange market.

Clearly there are investment opportunities in the currency market – ones that are no more risky than playing the stock market. It’s a question of finding the way of taking advantage of them that is right for you and your financial objectives. So why do so many folks consider the foreign exchange market highly risky?

The answer is leverage. Those who call the currency market highly risky fail to differentiate between the market and the participants. It’s not that the Forex market itself is risky. It’s that traders and investors are offered the opportunity to play the market with a high degree of leverage. In the stock market leverage is limited to 2:1, meaning you can buy twice as much stock as you have cash in your account by borrowing the difference (day traders often are allowed to use somewhat higher leverage). In Forex it is possible to trade at 50:1 or higher leverage. Successful traders know how to use leverage judiciously and to their advantage – this takes experience, time and diligence. Many traders in the Forex market do not know how to use leverage to properly manage risk. This aspect of risk management is a key consideration as we review new Trade Leaders for our investment program.

Forex gets a bad rap – a big part is due to irresponsible traders who have no experience or risk management strategy. I also believe Forex gets a bad rap because of misinformation. People hear a story here or there and see liquidity and leverage and make assumptions. And, you know what happens when you make assumptions.

Are you a Smartie? Get the facts. Check out our free e-book “The Smarties’ Guide to Alternative Investing in the Foreign Exchange Market”.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

In the United States this week, we were twisting and shouting like a 1960s disco track, while Italy wasn’t feeling the amore from financial officials and Greece wasn’t succeeding in its Olympic financial fiasco. Here are the top posts from last week:

The markets were expecting the Federal Reserve to announce Operation Twist, in which the Fed would sell short-dated Treasury debt and use the proceeds to buy long bonds. The Fed initiated a similar act in the 1960s, but with today’s numerous economic uncertainties – high unemployment rates and consumer debt – this small step is unlikely to create much spending. While America grappled with its monetary quandaries, Europe tried sorting its financial flounders. Standard & Poor downgraded Italy’s credit rating, saying arrivederci to the country’s A+ grade and ciao to its A mark with a negative outlook. Across the Adriatic Sea, Greece was also continuing to experience its continued economic pounding as it straddled the brink of default. The European Union

commissioner has said “the EU will not abandon Greece or let it default uncontrollably.” France is planning a 10 to 15 billion euro recapitalization plan for five top banks combating the debt crisis, causing a formal denial from financial ministries. The ministries said the government held discussions with leading banks about their state of heath, but denied bailout offers. One top financial executive said “French banks have a sufficient capital base compared to other European banks and they are making profits.” Also in Europe, the Swiss bank UBS’s chief executive resigned Sept. 24 after a $2.3 billion rogue trading loss. Oswald Greubel’s resignation ends days of speculation about whether or not he would retain his top post among one of the biggest scandals to hit the Swiss bank.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

As we mark its 10th anniversary, it’s clear that Sept. 11, 2001, continues to impact our country’s financial infrastructure. Here’s some perspective as well as our check-in on this week’s headlines:

The destruction of the World Trade Center back on that frightening Tuesday morning halted the markets, closing the New York Stock Exchange for four days. At the time, the U.S. was sliding off the bubble burst and was battling a recession from March 2001 to November 2001. Fast forward some years to the economic downturn of 2008 and the current crisis stamped by Standard & Poor’s downgrade of the nation’s AAA credit rating. The past decade’s fiscal rollercoaster has cranked to a higher level as jobs thwarted downhill. President Barack Obama took to the national airwaves on Sept. 8 in a televised speech, challenging U.S. lawmakers to enact a $447 billion package of tax cuts and new government spending that aims to stimulate a stagnant economy. As jobs have been butchered, so have hedge funds, especially as the worldwide economic chaos broils. Experts say several big hedge funds such as MLM Marco Fund are poised to face steeper losses before 2011 turns 2012. The Dow Jones Credit Suisse Core Hedge Fund Index dropped 3.76 percent as of Aug. 31 compared to a 3.1-percent dip in the S&P 500 index. Beyond our nation’s borders, the euro/dollar has slide into a six-month low, catalyzed by Greece’s slumping finances. The country last week faced a chance that it would run out of money in October when expected to fall short of 1.5 billion euros without the next round of help. What’s next?

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

As we said goodbye to summer this past Labor Day weekend, we took a break from anticipating the arrival of the New England fall foliage to check out the world currency market this past week. Here are our top headlines from the week:

Nonfarm payroll numbers were released Sept. 2, showing that, for the first time in 11 months, the economy failed to add new jobs in August. Market reactions to this news sent stocks declining, increasing fears of a recession while driving bonds, gold, and the Swiss franc higher. Considered one of the only remaining safe havens for investors, the Swiss franc continues its high demand. As a result, yields for short-term Swiss government debt turned negative Aug. 30 for the second time in a row, meaning that those who invested in these assets paid more for them than they will receive when they fall in three months. Recent numbers also show that gold, another safer investment, rose 12 percent in August. Meanwhile, a combination of the S&P downgrade and the European debt crisis led investors toward Treasuries and bonds, which grew 2.8 percent and 1.99 percent, respectively. In other news, Japan’s newly appointed prime minister Yoshihiko Noda (previously the finance minister) has signaled that a new approach will be taken to ease Japan’s economic issues due to the rising yen.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Summer may be drawing to a close, but the latest news in the world currency markets continues to bring the heat. Check out the top stories we’ve been reading this week:

Steve Jobs stepped down as CEO of Apple Wednesday, signaling a momentous change for the technology industry. While many were anticipating an enormous drop in Apple’s stock, it closed Thursday down only 0.65 percent. By comparison, recent numbers show that the Standard & Poor’s index has dropped 6.7 percent ($1.03 trillion) since its Aug. 5 downgrade of U.S. debt. Federal Reserve Chairman Ben Bernanke’s speech last week in Jackson Hole, Wyo., didn’t reveal much about QE3, but he did announce that the Fed will extend its meeting in September from one to two days in order to discuss future ways to relieve the economy. Market volatility as a result of these economic issues continues to affect the currency markets, as all major currencies have moved higher against gold, despite gold reaching record nominal highs of $1,913.50 per ounce. Japan once again took steps to control the yen, this time by creating a fund backed by the government that supports exporters who feel the weight of the rising currency. Also this week, German Chancellor Angela Merkel and French President Nicholas Sarkozy met to discuss plans for a financial transaction tax, the effects of which could potentially increase market volatility and “threaten London’s status as the world’s biggest foreign exchange center.”

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

I came across a poll being run by the folks at BabyPips today. The question is "Do you usually trade using hedging, i.e. making the opposite trade of the one that is currently open?" When I checked on the results this morning it showed that 29% of respondents responded that they do indeed use this sort of "hedging" (though I couldn't see the actual vote count). This strikes me as a very high number, considering there is no economic benefit to this activity, and it can actually cost the trader money in the form of additional spread and carry costs. Maybe it's a function of BabyPips being largely a newer trader oriented forum.

In retail forex, "hedging" has long been a hot-button subject. When the NFA ruled that US brokers could no longer use that type of accounting ("hedging" in this fashion is nothing more than a method of accounting), it created something of a firestorm among traders. My No More "Hedging" for Forex Traders post at the time remains by far the most commented one on my blog, with strong views expressed on both sides.

Needless to say, this sort of "hedging" will not be among the risk management subjects I will be discussing in Wednesday's webinar. Instead, the focus will be on understanding volatility in the markets so one can be better prepared both for the risks implied and the opportunities it presents.

As a little bit of a taste, take a look at this chart.

What you see here is a comparison of daily volatility between the S&P 500 and the USD Index. The plots show the percent change for each market for each day, expressed as a positive figure (so a -1.5% would be plotted as +1.5%). As we can see, the stock market has moved around quite a bit more than the dollar has since the beginning of July, a time which encompasses things like the US debt ceiling debate and continued European sovereign credit issues. There may be a couple of sessions where the dollar was more volatile, but mostly the stock market moved markedly more than the currency index. That means on a strictly price volatility basis, the USD Index is quite a bit less risky than stocks. This is something investors looking for opportunities to diversify need to know.