Dividend vs. Treasury Yields

The dividend yield of the S&P 500 is above that of the ten year Treasury for the first time since the financial crisis. Before that we have to go all the way back to the 1950's to find a time when this was the case.

The kicker... stock dividends have only made up about 45% of total S&P composite stock returns over the past 100 years, while Treasury bond coupon payments have made up north of 96% of Treasury bonds returns over that same period (see below). What this means for an investor is unless you think dividends will be cut and/or capital appreciation will be negative (i.e. corporate America will shrink in terms of nominal value), stocks are poised to outperform.

My take... stocks appear to be very cheap relative to bonds for investors with a long-term investment horizon, while near term investors need to be careful as we seem to be in a world that is likely to have binary outcomes (i.e. either a boom or an absolute collapse).

The remaining 55% of S&P stock returns have been in the form of capital appreciation, which has become increasingly important since the 1950's (see above), as corporations reinvested earnings back into their businesses / bought back shares (vs paying out dividends), while investors evaluated the relative merits of equities relative to bonds (see the much tighter relationship to bonds, which ratcheted up P/E multiples).

Source: Irrational Exuberance

S&P 500 / VIX Matrix

As a follow up to last week's VIX as a Predictor of Equity Returns and Model Building / Data Mining posts, I put together the following two 'VIX Matrix' tables. These tables show the:

• One month forward return of the S&P 500
• One month change in the VIX index

against a number of scenarios involving the one month month change in the VIX and the absolute value of the VIX since its 1990 inception.

• S&P 500: Less than -1.0% = Red, -1.0% to 1.0% = Yellow, Greater than 1.0% = Green
• VIX: Less than -2.5% = Red, -2.5% to 2.5% = Yellow, Greater than 2.5% = Green

Lots of interesting information in these tables that I won't bother summarizing (look at it yourself), except to say that even in these turbulent times (bull market 90's, roller coaster 00's), markets were (on average) very mean reverting.

Note that there are plenty of limitations to these tables, most of which involve the limited data points for a number of the cells.

One-Month Forward S&P 500 Performance

One-Month Forward VIX Change

Update: much more on the above from my friend Bill over at Vix and More blog.

Source: Yahoo Finance

Harvard Endowment's Historical Returns

We've detailed Harvard's Endowment's struggles in recent months. New expectations are the reported 20+% decline was highly optimistic. Looking at Harvard Endowment's historical returns, we can guess why the deflationary environment we've experienced would cause the portfolio so much pain.



Harvard's endowment has become increasingly reliant on capital gains vs. income over the past 20 years, with income returns accounting for less than 2% of total returns in 7 of the past 8 years. In an environment characterized by asset deflation and equity market collapse (i.e. the past 6 months), capital gains get crushed.

Are Convertible Bonds a "Screaming Buy"?

Investment grade corporate bonds have "outperformed" high yield bonds, which have "outperformed" convertible bonds, which have "outperformed" the S&P 500. Why the "quotes"? Because the best performing of the bunch is still down more than 10% YTD.

While it is hard to look at the above chart and not see at least some value, convertible bonds are what catches my eye as they have performed like equities, even though they are (per the WSJ):

part stocks, part bonds. They act like bonds and usually pay interest. But, as an added kicker, they give holders the right to convert the securities into stocks at a certain price. The market is normally less volatile than stocks, but the securities can have the same upside if a company rebounds.

The massive hedge fund unwind has sent convertible bonds reeling. Back to the WSJ:

Hedge funds, which at times owned as much as 70% of the outstanding convertible bonds, traditionally try to protect themselves by shorting, or borrowing and selling, shares of the same companies, profiting from the difference in the movement of the securities. But some funds did a poor job hedging themselves, or didn't do much hedging at all, figuring the market wouldn't tumble, traders say.
At the same time, some funds focused on convertibles borrowed as much as $5 for each $1 of equity in recent years, leverage that for some has turned small losses into huge ones. A 10% loss can become a 60% drop if a firm's borrowings amounted to five times its capital.

In other words, technical rather than fundamental factors are at play qualifying these for the latest installment of screaming buy. Does anyone know of a good convertible bond fund?

Source: Barclays

Asset Class Returns... Nowhere to Run

Unless things turn around dramatically, October YTD is going to look even worse...

Dow Jones: Long-term Perspective

Don't get me wrong, the recent downturn in the equity market has been brutal (and appears brutal in the first chart below).

However, looking at that same DJIA data using a log scale (a log scale is a better method of showing long term compounded data), a different picture emerges. A picture in which equities appear to have grown above trend since the mid-1990's and may just be reverting back to its long-term average.

Equities: Expect the Unexpected

With the Dow up a whopping 11.1% yesterday (the 6th highest figure EVER), what should we expect going forward? Well, looking at performance of the DJIA in the year FOLLOWING the largest single day increases over the last 80 years we should continue to expect... the unexpected.

Is the Euro Decline a Signal of E.U. Trouble?

There is some great analysis as to why the Euro is plummeting / Yen is rallying over at Investor Insights, but David Merkel is much harsher in his analysis of the Euro and E.U.:

It is possible that the current crisis could destroy the Euro, and possibly the EU. I think of the Confederation, where the economic pressure became so great that an extra-constitutional coup took place to create the Constitution, and implicitly, the fiat Dollar that we live with to this day. Without political unity, fiat currencies have short shelf-lives. Alternatively, the crisis could create a Federal Europe where the central government has significant powers to the degree that France in the Eurozone would be similar to Texas in the US. I don’t see that as likely; there is not the same degree of trust across the Eurozone as there is in the US.

Cliff dive below:

Who Bravely Dares Must Sometimes Risk a Fall

Yesterday we detailed how a spike in the VIX has historically presented a buying opportunity. Today, we'll analyze what to expect from this past month's historic collapse.

Over the last month (defined below as every 22 trading days to account for the different length of a month), the S&P 500 has lost almost 15% of its value. Of the past 14,282 one-month rolling periods (going back to 1950) this is the 34th worst period (only 0.2% were worse)! We've finally seen short-term investors running for the hills and Cramer invoked even more fear among his boo-ya viewers telling them:

"Whatever money you may need for the next five years, please take it out of the stock market. Right now. This week. I do not believe that you should risk those assets in the stock market."

For the record, if you NEED a certain amount money in any five year period... do NOT EVER invest it all in equities. Not sure why Cramer didn't relay this bit of advice to his viewers BEFORE the recent 40% drop, but I digress...

So with Cramer thinking Armageddon and EVERY contrarian investor drooling over Cramer's comments, we ask... how have equities performed after similar five day periods of (under)peformance?

Looking at the data all the way back to 1950, equity markets have actually done quite well, returning more than 15% over the ensuing 12 months following a similar one month drop.

Again, while I am not bullish on equities as the economy still has a lot of unwinding to do (and lets not forget that whole frozen credit market thing), I will keep an eye out for buying opportunities in select names (i.e. canned food and taser companies).

Quote: Tobias Smollet

Long Bonds, Short Equities

We've looked at this in the past with our post Where's the Equity Premium?, but worth noting again. Over the past 11 3/4 years, equities have underperformed bonds in the U.S. (comparing the S&P 500 with the Lehman Brothers Aggregate Bond Index INCLUDING REINVESTED DIVIDENDS / COUPONS).

Unfortunately it is even worse from an investment point of view. Investors typically don't buy once and hold, rather they continually invest. Assuming an investor had invested $1 per month in either stocks or bonds, they would have an identical return over the past 16 YEARS!

With the earnings component of equities under pressure and the relative cheapness of U.S. Bonds, look for bonds to continue their recent outperformance in the months / years to come.

Biller Miller Redux

We've already visited 'since inception performance' for legendary investor Bill Miller's Legg Mason Value Trust which shows underpeformance vs. the S&P 500. Now comes further questioning as to whether he should lose the "legendary" tag altogether following the funds large holding in Freddie Mac equity (apparently as much as 30mm more shares than we listed here).

From Joe Nocera at Executive Suite:

Back in 2001, when Bill Miller was viewed as one of the world’s greatest investors, I edited a story about him at Fortune magazine. Mr. Miller, of course, is the manager of the Legg Mason Value Trust mutual fund, whose claim to fame is that he beat the Standard & Poor’s 500-stock index for 15 straight years. (It was 10 straight when Fortune published its story.) In the last few years, however, his fund has stumbled badly. Indeed, there are those in the investment community who whisper that Mr. Miller was never really a truly great investor. Rather, he was akin to the guy who flips a coin and it comes up heads 15 straight times — a product, that is, of randomness rather than skill.

Source: Dealbook

August Hedge Fund Returns.... Where's the Alpha?

Source: Barclay Hedge Fund Indices

DJIA: Continued Downside?

With the Dow down 241.81 points today, I thought the charts below (inspired by a post / email exchange I had with Edward from Credit Writedowns) were fitting:


My guess? Volatility will continue to be the norm and we have not yet seen a bottom...

Bill Miller vs. S&P 500

Per the WSJ:

Massachusetts' pension fund has dismissed five managers that handled its $1.8 billion U.S. equity portfolio, including Legg Mason Capital Management, a Legg Mason Inc. unit.

The decision is another blow to Bill Miller, manager of the Legg Mason Value Trust, which has lagged the Standard & Poor's 500-stock index during the past three years since its 15-year streak of outperformance ended.

It's been a harsh reversal of fortune for Mr. Miller who outperformed the S&P 500 fifteen straight years from 1991-2005. With that kind of run, performance must still be strong historically relative to the S&P 500... think again.


Source: Yahoo Finance

Global Stock Market Performance (7/31/08)

1 Month, 3 Month, and YTD Equity Performance in Local Currency.

Source: Investment Postcards

Where's the Equity Premium?

The Secret Sauce Revealed...

There was a guess that the 'Secret Sauce' was a Corporate Bond Index and one that the 'Secret Sauce' was instead a Treasury Index. As these (actually a combination of the two in the form of a Long Government / Credit Index) formed the 'Secret Sauce', I thought I'd take a look at how well these two security types have performed relative to one another...

The results actually surprised me. While there were somewhat large year to year variations, since 1973 the cumulative returns are remarkably close.

World Equity Returns as of 7/18/08

Go to Investment Postcards for all the data...

Run on Banks --> Banks Run

Following rumours of a bank run, banks ran.

Last week the S&P Financials Index returned a whopping 11.4% (the 6th highest week since its inception back in Sept. 1989) AND this is only the second highest week of 2008 (it returned 11.9% the week of the Bear Stearns bail out)! So far this year, in 29 weeks time, we have seen 13 of the largest drops and 6 of the largest gains in the history of the index (as defined by bottom / top 100 weeks of the ~1000 week history).













So how have financials reacted after weeks similar to last's? On average, the S&P Financial Index maintained momentum returning 9% over the next 6 months and 11% over the next year and only one of those 8 other times (that we have data for) did it show a loss over those next 12 months.

While I am not convinced that I should dive in on the long side, I am ready to pounce if the government continues to squeeze those on the short side...

Sell in May, Don't Go Completely Away...

As the saying "Sell in May, Go Away" implies, the S&P 500 has historically performed dramatically better in the November-April time frame. EconomPicData noticed this trend has continued dramatically in 2008, but questions the desire for many to hold cash six months out of the year.

So, I decided to test out a few alternatives for the May-October period and one stood out from the rest since the benchmarks 1976 inception (not sure if that is or isn't a hint), now referred by my inner circle as the "Secret Sauce".



























So, any guesses on what this "Secret Sauce" is?

UPDATE: so far I've gotten Emerging Market Equity, oil, and real estate among the various guesses. Lets take a look at a variety of them (the different starting points are due to index inception).



























As can be seen, none have outperformed the S&P except oil (and that just barely). Maybe my "Secret Sauce" is better than I thought?

Hints:

• What does well when equities tank (i.e. becomes even more uncorrelated)?
• Think long term (not just this business cycle)
• If equities typically underperform in the May-October time frame, where would an investment manager likely put it?

UPDATE(2): Secret Sauce Revealed