Put Selling as a Replacement For Stocks

The higher that market implied volatility becomes, the more attractive put selling (as a replacement to being long stocks) becomes.

The chart below outlines one such example, this being the put option payoff structure of March 16th, 2013 expiry puts on the ETF SPY. As implied volatility moves higher, the put premium (think of this as the insurance premium you are selling) moves higher (i.e. the payoff structure moves up).

In the example below, the current payoff over the next 10 months of an at the money put is almost 10%, which can be thought of as the "upside" should stocks stay at current levels or move higher, while downside moves in the same 1:1 fashion as owning the underlying SPY ETF (but you are cushioned by that 10%). If you want more cushion in the form of allowance for downside movement, you can sell further out-of-the-money puts (but collect a smaller premium).

A few months back, I outlined that implied volatility was so low that I was replacing some of my long positions with long call options (and short positions with long put options). If volatility moves higher, I will likely be doing the opposite and replacing these long call / put positions with short calls / puts.

Note: the payoff structure in the above chart should be moving down at a crisp 45 degree angle for all of the above put payoffs (the reason they don't is I am being lazy in the number of data points I used to create the chart).

Source: Yahoo Finance

First Quarter GDP Revised Down to 1.9%

Marketwatch details:

The U.S. economy ran into a deeper soft patch in the first quarter than initially estimated, a government report showed on Thursday.

The Commerce Department estimated that the economy grew at a 1.9% pace in the first quarter, slower than the 2.2% rate initially reported.

This is down from a 3.0% growth rate of real gross domestic product, the output of goods and services produced in the U.S., in the fourth quarter.

Source: BEA

What Happened to the Great Bond Sell-Off?

It's amazing that it was only a bit more than two months ago that I wrote this post defending bonds against what was labeled the "Bond Market Arab Spring". It's also amazing how wrong pundits continue to be as Long Treasuries have now caught up to the S&P 500 year-to-date after the ten year Treasury reached an all-time low.

Source: Yahoo

Existing Home Sales Rise Across the Board

While the overall level of existing home sales is still well below the bubble peak (4.62 million vs. 7+ million in mid-2005), the trend is positive across housing markets and prices.

Source: Realtor

Leading Economic Indicators Turn Negative

Source: Conference Board

(U.S.) Relative Strength

Despite the recent turmoil, unlike when I showed this chart last August (a time when the dollar was selling off and gold / commodities were roaring), the ETF's showing the least strength are all currency or real assets. I believe this accurately reflect the current (relative) strength of the U.S.

Source: Yahoo Finance

Checking in on Inflation

Marketwatch details:

Inflationary pressures are fading, just as Federal Reserve officials expected. But don’t think that the decline in the inflation rate will automatically lead to further quantitative easing by the Fed.

The consumer price index was flat in April, the Bureau of Labor Statistics reported Tuesday. And the CPI is expected to drop by at least 0.2% in May on account of the big drop in gasoline prices.

The CPI has increased 2.3% compared with a year ago, down from a 2.7% year-over-year rate in March and 3.9% last September. By May, the year-over-year rate could slow to 1.8%, below the Fed’s longer run target.

Looking into the details, there isn't much of a pattern, but it looks like most "stuff" we consume (clothes, food, medicine) increased in price at a faster pace than the headline figure, with the exception of alcohol (hence, I'm not complaining).

Source: BLS

EconomPics Recap

I just came to the realization that I haven't had an EconomPic recap since March 9th, so here goes:

Economic Data

• Trade Deficit Blow Out
• The Consumer is Back... Consumer Credit Positive (even excluding student loans)
• Ugliest Employment Chart You'll See?
• Employment Market Continues to Muddle Along
• Personal Income and Outlays... A Few Charts
• GDP Breakdown
• How's That Austerity Working?
• Leading Economic Indicators (less Fed Control) Negative
• Retail Sales Continue to Show Strength
• State Taxes
• What's Another Trillion?

Investing

• Stocks for the Long Run?
• When Leverage Attacks
• April ETF Performance Recap
• Baby's Got Sauce... Checking in on the World's Greatest Rotation Strategy
• More on that Treasury Blood Bath
• The Power of Momentum
• Why Investors are Reaching for Yield?
• Chinese Treasury Holdings Back to 2010 Levels
• The VIX as an Equity Hedge
• Baseball Valuations Soar
• "Risk On" in Q1
• Not All Bonds are the Same
• About that Treasury Blood Bath

Random

• Quantifying March Madness

And your video of the week... Beastie Boys (RIP MCA) closing out 'The New Style'.

Trade Deficit Blow Out

Remember when we thought the U.S. was going to export our way back to prosperity riding European and emerging market aggregate demand (that wasn't a crazy statement even a year ago... promise)?

BusinessWeek details the reality:

The trade deficit widened more than forecast in March as American demand for crude oil, computers, automobiles and televisions propelled imports to a record.

The gap grew 14 percent to $51.8 billion, the Commerce Department reported in Washington today. The median estimate of economists surveyed by Bloomberg News called for an increase to $50 billion. A 5.2 percent jump in imports, the biggest in more than a year, swamped the 2.9 percent gain in exports, which also reached a record.

Change in Trade Balance - Chain-Weighted 2005 $$ (i.e. real change in 2005 dollar valuation)

With the re-emerging crisis in Europe since the March trade balance print (and what will likely be a resulting oversupply of goods coming from emerging Asia), don't expect this trend to slow any time soon.

Source: Census

Stocks for the Long Run?

While the below chart cherry picks one of the best performing fixed income sectors, it is still pretty amazing.

Bonds (defined in this example as the Barclays Capital Long Government / Credit index) have now outperformed stocks (defined as the S&P 500 index) going back to November 1980 (10.7% annualized vs. 10.4% annualized) and has more than doubled the performance of stocks over the past 15 years (239% vs. 108%). Note the chart below is total returns including reinvestment coupon payments and dividends.

Is this likely to continue?

Unless capitalism as we know it ends, the answer is a simple 'no' over the next 15 or 32 (or even 3-5) years. The government / credit index shown above yielded a whopping 13.18% as of November 1980 and the next 32 years were the great bond run that has resulted in the current paltry yield of 3.89% (just 7 bps off its all-time low).

Source: Barclays Capital / S&P

The Consumer is Back... Consumer Credit Positive (Even Excluding Student Loans)

SF Gate details:

Consumer borrowing in the U.S. surged in March by the most in more than a decade on growing demand for educational financing and autos.

Credit rose by $21.4 billion, the biggest gain since November 2001, to $2.54 trillion, Federal Reserve figures showed today in Washington. The advance was paced by a $16.2 billion jump in non-revolving debt, including student and car loans.

Americans may have been trying to get school financing before a possible increase in interest rates takes place on July 1. Rising consumer confidence also means that households are more willing to take on debt to boost spending, which accounts for about 70 percent of the economy.

I've been showing the below chart for some time. It shows the year-over-year change in revolving consumer credit, non-revolving consumer (excluding student loans), and student loans. Headline consumer credit has been growing since early last year, but this had been solely due to student loans (not necessarily a bad investment, but it doesn't reflect consumers re-leveraging for goods and services).

Well, as the chart shows, after a strong March where revolving consumer credit (i.e. credit cards) jumped 7.8% month over month and non-revolving (excluding student loans) posted a positive print... the day has arrived in which the consumer is no longer deleveraging in nominal terms (important for all that nominal debt out there).

We'll see if this continues, but the consumer looks like they may be back.

Source: Federal Reserve

Ugliest Employment Chart You'll See?

Per Felix Salmon:

As Mike Konczal noted this morning, a key indicator of labor recession is still in force: if you’re unemployed, you’re still more likely to drop out of the labor force entirely than you are to find a job.

Let's see how that trend has fared over the longer term.

The chart below shows the ten year rolling change in the number of individuals employed divided by the ten year rolling change of those individuals no longer in the labor force. Any number over 1 means that the marginal person of working age is more likely to have gotten a job ten years later than to be out of the labor force.

In the late 1980's / mid 1990's, this marginal individual was a whopping 8x more likely to have found a job than no longer be looking. Today? 0.35x, which means that the marginal individual of working age (relative to 2002) is 3x more likely to be out of the labor force, than to have found a job.

Source: BLS

Employment Market Continues to Muddle Along

The NY Times details:

The nation’s employers added 115,000 positions on net, after adding 154,000 in March. April’s job growth was less than what economists had been predicting. The unemployment rate ticked down to 8.1 percent in April, from 8.2 percent, but that was because workers dropped out of the labor force.

The share of working-age Americans who are in the labor force, either by working or actively looking for a job, is now at its lowest level since 1981 — when far fewer women were doing paid work.

The first chart shows the unemployment rate from the payroll survey, which shows the headline improvement.



The next chart shows the issue with the calculation. The reason for the improvement in the unemployment rate is due to the continued departure of millions from the labor force (if you're not looking for a job, you're not technically unemployed).



The final chart attempts to account for the declining labor force through a cyclical adjustment. Similar to Shiller's cyclically adjusted P/E ratio, the below normalizes the labor force participation rate through a 10 year rolling average, then assumes the difference in that average and the latest number of participants are unemployed (or in the case of a rising workforce, it reduces the number of unemployed).

What we see is that the labor force was potentially much stronger than headline figures indicate throughout the 1960's - 1990's as the participation rate increased (in no small part due to women entering the labor force), as it took some time for the labor market to accommodate the increase. Since 2000, the reverse has been true as the participation rate has trended down... now at the lowest rate since 1981. Taking the current number of workers and assuming a cyclically adjusted labor force, unemployment is still above 10%.



Which seems more accurate at first glance.

Source: BLS

When Leverage Attacks

The real estate market is certainly heating up in the San Francisco, my new city, despite the broader Case Shiller Home Index still hovering near cyclical lows.

How soon we forget.

I will admit, real estate does sound like close to a sure thing with mortgage rates at record lows, potential inflation on the horizon, negative real rates in savings accounts (i.e. zero opportunity cost), and prices as much as 50% or more off. And it may be, but not necessarily when leverage is introduced.

But, first, let's take a look at housing without leverage.

Case Shiller Index (without Leverage)

As last week's post The Power of Momentum outlined, the broad Case Shiller Composite-10 index was stagnant from 1987 to 1997, rocketed between 1997 and 2006, and has tumbled since. However, over this entire period we have seen a healthy increase in the price (a bit more than the rate of inflation... assuming growth using the composite-10 index, a house worth $100,000 in 1987 is now worth a bit less than $250,000)

Case Shiller Index w/ Introduction of Leverage

As James Montier of GMO has pointed out:

Real risk is the risk of permanent loss of capital.

Investments made with borrowed money reduces the range that the investment can move without causing a permanent impairment of capital.

Using the same Case Shiller Composite-10 index data as in the above chart, we introduce leverage using the following rules:

• 5x leverage (i.e. a 20% down payment... pretty standard, though not so much during the bubble)
• If prices rise, sell your investment property each year and with the equity gains, buy a more expensive property at 5x leverage

Simplifying Assumptions:

• Mortgage payments = rental receipts
• No taxes / transaction fees

Using the same $100,000 house as an example (this time with 20% down), we get the following:

Returns were actually okay from 1987 to 1997, but were dwarfed by the boom seen from 1997 to 2006 as property values, debt to go along with it, and equity SOARED, taking the original $20,000 investment to $3.7 million.

BUT, it all came crashing down. As property values declined, the new outsized level of debt remained, which resulted in all that hard earned equity flipping negative (in the above example) by early 2008. 5x leverage means that when the value of the property turned down just 20%, the entire equity stake was gone.

Takeaways....

• Real estate investment is not riskless, especially when leverage is introduced
• Down payments of 20% do not prevent bubbles (as the chart above shows, asset appreciation allows an investor to put gains back in the market)

A case can be made (specifically within real estate) that negative equity does not equal permanent impairment. As long as payments continue to be made, an investor is still alive. While this is true, it does completely reduce liquidity (i.e. you can't sell without making the loss permanent) and it require an investor to make mortgage payments that are higher than the current market clearing price for similar properties.

Source: S&P

Personal Income and Outlays... A Few Charts

The Economic Populist notes:

While disposable income increased by 0.4%, when adjusted for inflation, disposable income was actually a 0.2% increase.

Over the longer term and on a real per capita basis, March marked the third month in a row in which disposable personal income printed a negative year over year figure, which shows just how how weak the employment recovery has been.

On the flip side of the income / consumption equation, has been solid spending (both in nominal and real terms), as consumers have reduced their savings rate below 4% (the savings rate had moved above 6% during the beginning of the crisis).

One area of real consumption weakness... energy in real terms. I am no expert as to specifics of what is making up the decreased demand (clean technology, less people driving to work, more people taking public transportation, etc...), but I will say that demand does tend to decrease when the price of good or service quadruples like energy has in recent years.

Source: BEA

April ETF Performance Recap

In a month where market pundits made it seem like we were experiencing a sell-off we have never seen before, markets were only slightly in risk-off mode, while EVERYTHING (except long treasuries) is now up for the year.

The question for investors is whether the risk-off environment was simply a pause following a sharp rise in risk assets in Q1 (i.e. just the temporary mean reversion seen below).

Or the beginning of a European crisis induced broader sell-off that is a continuation of Q3 2011 (as seen below).

Source: Yahoo Finance

GDP Breakdown

Bloomberg details:

The U.S. economy expanded less than forecast in the first quarter as a smaller contribution from inventories overshadowed the biggest gain in consumer spending in more than a year.

Gross domestic product, the value of all goods and services produced in the U.S., rose at a 2.2 percent annual rate after a 3 percent pace, Commerce Department figures showed today in Washington. The median forecast of economists surveyed by Bloomberg News called for a 2.5 percent rise. Household purchases increased 2.9 percent, exceeding the most optimistic projection. Homebuilding grew the fastest in almost two years

So there you have it... a VERY strong (perhaps unsustainable?) contribution from consumption, reduced impact from inventories, the beginning of contribution from residential investment for years to come (after years of decline), mixed trade, and what is likely to be negative impact from the government sector for years.

Source: BEA

More on that Treasury Blood Bath

Just about a month ago when everyone was calling the end of the 30 year bond rally, I noted.

While any sell-off has the potential to become the large sell-off EVERYONE has been waiting for (economic data is improving, yields are very low, inflation is ticking higher), I am not yet convinced it's the sure thing these "experts" want you to believe.

But, I guess if you keep making the same prediction, eventually it will come true.

Apparently, we need to keep waiting.

A weak (and deteriorating) Europe, low inflation, low growth, an uptick in risk-asset volatility, and continued piling into the asset class by investors (mutual fund flows remain positive), businesses (looking for yield on cash), and government entities (QE) have not only supported the asset class, but made it one of the top performing asset classes month-to-date.

Source: Barclays Capital

The Power of Momentum

Gary Antonacci of Optimal Momentum blog has a great white paper out titled 'Risk Premia Harvesting Through Momentum' that details...

Momentum is the premier market anomaly. It is nearly universal in its applicability.

Gary then outlines how an investor can easily apply momentum through the use of asset pair modules to "effectively harvest risk premium profits". I highly recommend anyone interested in momentum or learning more about momentum to check out the (easy to understand) white paper that you can download here.

Reading the paper gave me an idea for a test that I felt would further show how universal momentum truly is. The test? How well would an investor have done applying momentum to the various cities that make up the Case Shiller Home Price Index, pretending (of course) that each city index was investable and liquid (i.e. things they aren't).

First, a quick update on the Case Shiller Home Price Index. To the Huffington Post:

The Standard & Poor's/Case-Shiller home-price index shows that prices dropped in February from January in 16 of the 20 cities it tracks.

The steady price declines have brought the nationwide index to its late 2002 level. Home prices have fallen 35 percent since the housing bust.

Prices in nine cities fell to their lowest levels since the housing bust. The average price in Atlanta fell 17.3 percent in February compared with a year earlier. That's the biggest annual drop in the history of the index for any city.

Yikes... let's see what momentum can do with this mess.

Rules...

1) Take the 6-month rolling return for each city

2) Allocate the next month to the city that had the highest six month return

How well would we have done?

The chart below outlines the performance of this relative strength allocation, the composite-10, and Portland (which happened to be the best performing city over this time frame... who knew).

For those keeping track at home, that's a 12.7% annualized return for the relative strength index vs. 3.3% for the composite-10 and 4.8% for Portland, despite there being no rule that allowed an investor to get out of the market.

Not too bad.

Source: Case Shiller

One reason I was drawn to Gary's paper is that it is remarkably similar to something I've been working on for the better part of the past year, which itself is based on conversations that I've had with Meb Faber from World Beta over the past few years. If you haven't read Meb's paper A Quantitative Approach to Tactical Asset Allocation, another strong recommendation.

How's That Austerity Working?

Bloomberg details:

The debt of the euro region rose last year to the highest since the start of the single currency as governments increased borrowing to plug budget deficits and fund bailouts of fellow nations crippled by the fiscal crisis.

The debt of the 17 euro nations climbed to 87.2 percent of gross domestic product in 2011 from 85.3 percent the previous year, official European Union figures showed today. That’s the highest since the euro was introduced in 1999. Greece topped the list with debt at 165.3 percent of GDP, while Estonia had the least at 6 percent of GDP.

Bloomberg continues...

Italy ended last year with the second-highest debt at 120.1 percent of GDP. Spain’s rose to 68.5 percent from 61.2 percent. Germany posted one of the only declines, with its debt shrinking to 81.2 percent from 83 percent, Eurostat said in the report. Only five euro-region nations -- Estonia, Luxembourg, Slovenia, Slovakia and Finland -- had debt within the euro- region’s limit of 60 percent of GDP.

This leaves indebted European countries in an awfully precarious situation.

On one hand they have limited firepower left with debt levels increasing relative to nominal GDP even as they push austerity measure (always important to remember the debt to GDP ratio will rise as long as debt increases more than GDP and that can be in the form of flat debt and declining GDP). On the other, even if the citizens throw out leaders that favor austerity, for those pro-growth, it is unlikely to help as it doesn't address the cause of the problem... the imbalances between countries with vastly different production capabilities, demographics, beliefs, yet a shared currency.

Source: Eurostat

Leading Economic Indicators (less Fed Control) Negative

Excluding the components the Fed impacts, the index is negative for the second time in three months, dragged down by the decline in the average work week.

Source: Conference Board

Why Investors are Reaching for Yield?

Because high yield is just about the only place you can get yield within the U.S. without taking on interest rate risk. The question is whether investors know / are comfortable with the credit risk they are taking.

Source: Barclays

Chinese Treasury Holdings Back to 2010 Levels

For years, the mainstream media reported that China was unloading Treasuries when in fact they weren't (Treasuries were purchased and listed as being held by the U.K., then regularly revised to China). BUT, recent revisions to the TIC Data shows that the slow down we witnessed in late 2011, was actually a rather significant decline.

To BusinessWeek:

The rise in holdings comes after China reduced its position in U.S. government debt in 2011 for the first time since the Treasury started releasing the data in 2001, as yields fell to record lows.

* Chinese + United Kingdom Holdings as some purchases flow through the U.K.

Some of this was simply a reallocation to higher yielding agency bonds, but it doesn't seem to account for that much of it. We'll see in coming months (data will now be revised by the Treasury on a monthly, rather than yearly basis) if the bottom holds at spring 2010 levels or if things are taking a much different turn in China than most market participants believe.

Source: Treasury

Retail Sales Continue to Show Strength

The Washington Post details:

Americans bought more electronics, started home improvement projects and updated their wardrobes last month, inspired by warmer weather and a healthier job market.

The increase capped a strong quarter of gains and contributed to a brighter outlook among economists for growth in the January-March quarter. Businesses are responding by restocking their shelves at a steady pace, a sign that they expect the trend to carry over into the spring.

More retail spending also helped offset a decline in confidence among homebuilders. And it could ease concerns about March hiring, which slowed to half the pace of the previous three months.

Source: Census / BLS

Employment Report: Not as Bad as I First Thought

Upon first glance, Friday's employment release was disappointing, but Scott Grannis pointed to something that does provide optimism.

In the past two months the household survey has made up for that lagging performance by posting growth of 740K jobs.

Below is a breakdown of the household survey broken down by the public (government) and private (business) sectors. The huge divergence accounts for how the household survey could show a net negative growth print for March, while the private sector grew by 336,000.

The private sector recovery over the last twelve months is now the same as the peak we saw last cycle (though that in itself was the "jobless" recovery). The main concern I see is whether the drag from the public sector will in itself cause the aggregate economy to stall, but this makes me much more optimistic than I was on Friday about a continued (albeit slow) recovery.

Source: BLS

The VIX as an Equity Hedge

Back in January I posted a pair of VIX / S&P 500 tables that outlined the performance of the VIX and the S&P 500 given recent changes in the VIX, as well as the current level of the VIX. In response, reader Nazumo asked:

In service of the perpetual quest to find cheap and reliable hedging vehicles, I'd be curious to see a third table: (change in SPX / change in VIX) against VIX.

That table is below, but first I'll try to explain in a simple manner exactly what we're looking at.

The x-axis shows how much the VIX has changed over the last month (as of Thursday, this would read a '0 to 2.5 point drop' as the VIX reads 16.70 vs 18.05 a month back), while the y-axis shows how much the S&P 500 has changed over the last month in percent terms (as of Thursday, the S&P 500 would read '2.5% to 5%' as the S&P 500 was up around 2.6%).

That gets us to the 8.4% average rise in the VIX over the next month based on these two historical factors (note that I am not saying this will happen going forward); certainly a nice hedge if you can get it should equity markets sell-off.

So, is the VIX a good S&P 500 hedge? Based on the above table and the previous tables which incorporate starting levels the VIX may be a good hedge when:

• Markets are calm
• The price of volatility, as a form of insurance, is cheap

In other words, the VIX may be a nice equity hedge.... when you don't think you need it. By the time you KNOW you need(ed) it, after markets sell-off or when the VIX index is rising, it is likely too expensive to be of value.

Source: Yahoo Finance

A Weak Jobs Report

While the payroll (i.e. business) survey showed a net gain of 120,000 jobs in March (which in itself was weak), the household survey (the survey used to calculate the unemployment rate) actually showed a decline. Note that while this may just be noise after a warm winter that may have pulled hiring forward, the net result is most likely a (much) weaker employment situation than previously thought.

The Washington Post details how the unemployment rate can fall in the face of lost jobs:

In March, the household survey showed that the number of people who say they have a job fell by 31,000 and the number of people looking for a job fell by 79,000. That lowered the unemployment rate to 8.2 percent.

As the chart below shows, both the headline unemployment rate and broader measure of unemployment dropped as people left the workforce.

Breaking this down further, we see a continued split in terms of the male and female population. Men continue to find work (though the number of men dropping out rose in March), while women continue to run into difficult times, losing jobs and dropping out of the workforce in sizable numbers (more than 300,000 left in March alone).

Which all adds up to a stalling (perhaps temporarily) in the number of hours worked per person (on average), while remaining at a level WAY below historically norms.

Source: BLS

Baby's Got Sauce... Checking in on the World's Greatest Rotation Strategy

Definitely not the world's best strategy, but I thought I'd try out a headline grabber. In fact, there is no legit reason I can think of that explains why this seasonal pattern should outperform going forward, BUT the results (both in and out of sample) are good enough that I won't be ignoring them.

I planned to provide an update on the "Secret Sauce" allocation strategy as soon as I started seeing all the "sell in may, go away" articles that always come this time of year. I didn't have to wait long.

To Marketwatch:

Those interested in doing some spring cleaning in their portfolios this month might be tempted to do the most radical spring cleaning of all: Sell everything and go to cash.

That’s because April represents the end of the seasonally favorable six-month period that began last Halloween, and the fast approach of the time when many will “Sell in May and Go Away.”

Which brings me to the Secret Sauce, amazingly now in its 5th year of in sample testing.

What is the Secret Sauce?

An alternative to the "sell in May, go away" strategy, Secret Sauce is sell the S&P 500 in May and then invest in the Long Government / Credit bond index (rather than sit in cash). The "strategy" takes advantage of data mining that showed the Long Government / Credit index outperformed the equity market for the May through October time frame over the 34 years between 1974 and 2008.

The amazing thing is that since I first revealed the Secret Sauce back in July 2008, the results keep getting better. The massive outperformance since 1974 (14.7% vs 10.6% annualized returns) with lower volatility (12.4% vs 15.8% monthly standard deviation) was met by even larger outperformance over the past few years (35.6% vs 8.5% returns over the last 12 months, 11% vs 2% annualized over the last five) resulting in $1 invested in the Secret Sauce in January 1974 now being worth $188 vs. $1 in the S&P 500 being worth $47.5 (assuming no fees, transaction costs, or taxes).

And the strategy's theme song... G Love & Special Sauce with 'Baby's Got Sauce'



Source: S&P / Barclays Capital

"Risk On" in Q1

Source: Bespoke

Final Q4 GDP Unchanged at 3%

Source: BEA

Baseball Valuations Soar

Let's pretend for the time being that Forbes doesn't just stick their finger in the air and make up these valuations (an M&A professor of mine in business school shared that teams have a lot of influence in the Forbes' valuations, hence it shouldn't be a surprise that the Dodgers valuation is a whopping 75% higher than last year when the owner would have preferred a lower valuation while going through a divorce and higher valuation this year when selling the team).

To Forbes:

The average Major League Baseball team rose 16% in value during the past year, to an all-time high of $605 million. In 2011, revenue (net of payments to cover stadium debt) for the league’s 30 teams climbed to an average of $212 million, a 3.4% gain over the previous season. But operating income (in the sense of earnings before non-cash charges and interest expenses) fell 13%, to an average of $14 million in part due to a 5.1% increase in player costs (including benefits and signing bonuses for amateurs), to $3.5 billion in 2011.

But that's not where the money is. It's all in the regional sports networks "RSN's":

The Rolls-Royce of the RSN model is the New York Yankees, who own 34% of the YES Network. The Bronx Bombers are the most valuable team in baseball, worth $1.85 billion, tying them with the National Football League’s Dallas Cowboys for the top spot among American sports teams and placing them second in the world to Manchester United, the English soccer team worth $1.9 billion. YES generated a staggering $224 million in operating income and paid the Yankees a $90 million rights fee in 2011.

So... teams earn an average $14 million each from baseball operations, while the Yankees earn $90 million just from their TV network. Which explains how the Evil Empire (i.e. the Yankees) can blow a seemingly unlimited amount of money on players, while the Mets (one of two teams that actually lost value in 2011) shed payroll because their owner got ripped off by Mr. Bernie Madoff (full disclosure if not already obvious... I am a bitter Mets fan).

Source: Forbes

Leading Economic Indicators Show Strength in February

Ken Goldstein, economist at The Conference Board details:

“Recent data reflect an economy that improved this winter. To be sure, an unseasonably mild winter has contributed to many of the recent positive economic reports. But the consistent signal for the leading series suggests that progress on jobs, output, and incomes may continue through the summer months, if not beyond.”

Source: Conference Board

Not All Bonds are the Same

The (overrated) bond sell-off took a breather today, perhaps rallying on news that iron ore demand from China was waning.

Regardless of the whether or not the sell-off is just noise (my guess until proven otherwise) or the reversing of what has been a 30 year trend, it's important to remember that not all bonds are the same.

In the face of the "huge" 2.1% Treasury sell-off (kidding) since the Treasury index hit its all-time high on January 31st (yes, all this news of a Treasury sell-off is when the index is 2.1% off its all-time high), we can see that quite a few sectors actually have positive performance over that time.

Source: Barclays Capital

State Taxes

The Rockefeller Institute details the continued, yet slower paced, growth in state tax collection in the fourth quarter:

Preliminary data for the October-December quarter of 2011 show further growth in state tax collections, with gains now coming for every quarter over two full years. However, such growth softened considerably in the second half of 2011. We will provide a full report on the October-December period after Census Bureau data for the quarter are available.

The Rockefeller Institute's compilation of preliminary data from all 50 states shows collections from major tax sources increased by 2.7 percent in nominal terms in the fourth quarter of 2011 compared to the same quarter of 2010. This is a noticeable slowdown from the 11.1 and 6.1 percent year-over-year growth reported in the second and third quarters of 2011 respectively.

The growth was dampened by a 3.8% decline in corporate taxes in Q4 2011 as compared to Q4 2010 (anyone's guess as to why Q4 2011 taxable earnings were lower considering "reported" earnings were higher is better than mine).

Over the longer term, we see that while state tax revenues have increased in nominal terms, they have declined over the past decade or so relative to nominal GDP. The chart below shows state tax revenues (by component) normalized to GDP, indexed at 1 as of December 1998 (the furthest back I could pull data). What we see is volatile, yet declining corporate taxes and a consistent decline in personal, sales, and overall taxes.

Why the decline?

Some initial thoughts.... the aggregate "state tax revenue pie" may be declining as states fight for tax dollars in a battle where nobody wins except corporations or perhaps economic growth is becoming less "taxable" as service sectors move underground (services seem to be harder to track than products) and products become less taxable as corporations outmaneuver states' ability to adapt to new technology.

Source: BEA / Rockefeller Institute

About that Treasury Blood Bath

Pundits, bloggers, experts, etc... have been calling for a Treasury sell-off going on 3-4 years now (here is a post of mine from January 2009 on that exact subject.... and one from October 2010...and one from January 2012) so it is no surprise that the recent sell-off has brought the bears back out.

Global Macro Monitor even says we may be starting what it refers to as the Bond Market Arab Spring.

Wow... that's bold. Let's see the beginning stage of the massive sell-off they are referring to.

Yeah... I don't see it (yet) either.

While any sell-off has the potential to become the large sell-off EVERYONE has been waiting for (economic data is improving, yields are very low, inflation is ticking higher), I am not yet convinced it's the sure thing these "experts" want you to believe.

But, I guess if you keep making the same prediction, eventually it will come true.

Source: Yahoo Finance

What's Another Trillion?

Statesman details:

The U.S. federal deficit was slightly smaller through the first five months of this fiscal year than the previous year. Still, the deficit is on pace to exceed $1 trillion for the fourth straight year, which could be an issue in this year's presidential election.

The Treasury Department said Monday that the deficit grew by $232 billion in February. That increased the imbalance through the first five months of the current budget year to $581 billion, or 9 percent less than the same period in fiscal 2011.

The Obama administration expects the deficit will reach $1.3 trillion when the fiscal year ends Sept. 30. The government ran a record deficit of $1.41 trillion in 2009 and a $1.29 trillion deficit in 2010.

While the scale of deficits has been alarming, it should come as no surprise given the huge incentives for politicians to push revenues lower and spending higher, as well as the strong dependence for improvement (of both the revenue and spending side) on a weak underlying economy.

Politicians like to be elected. On the spending side of the equation, the easiest way (it seems) to be elected in the U.S. is to spend during prosperous times, as voters (not surprisingly) like to feel prosperous during these prosperous times (hence the limited number of times the below chart turns negative). One issue is that spending moves even higher during downturns due to all the social safety nets that kick in, pushing the deficit higher and higher each business cycle.

Similarly, tax revenues depend on these same politicians that want to be elected (during good times, why not cut taxes?) and shows a similarly strong relationship with the same underlying economy. In fact, revenues are similar to the S&P 500 in that they grow at roughly the same rate as nominal GDP over the long run, yet exhibit larger swings at turning points.

So... for the average voter of this great land, taxes are always too high and spending too low (hence deficits tend to remain even during prosperous times) and when downturns hit, the US finds itself long equity beta on the revenue side and short put options (social safety nets) / inflation (cost of spending) on the spending side.

Is it any wonder we're in this situation?

Source: Treasury

Quantifying March Madness

BostonSportsHub provides a breakdown of how the NCAA bracket has performed by seed going back to 1997:

The first step in filling out your bracket is to understand the importance of seeding. Unless you are a complete novice to the religion that is March Madness, you know that in general the better the seed, the better the team. There are of course exceptions to this rule. At times the committee loses its mind, but in general the seeding is a fairly accurate representation of the quality of the teams. Here is how the seeds have performed on a round by round basis since 1997.

The results...

Round One: Winning Percentages by Seed

Until you get to the 5 seed, upsets are rare.

Round Two (To the Sweet 16): Winning Percentages by Seed

One seeds rarely lose, but upsets are pretty common two seeds and out

Round Three (To the Elite Eight): Percent that Get Through by Seed

One seeds keep rocking, while a four seed is almost as unlikely as an eight seed to get through.

Round Four (To the Final Four): Percent that Make Up the Final Four

Taking the unlikely "flyer" this far yields minimal results.

So, everyone should just take the #1 seed right? If the goal was to get the least number wrong... sure. BUT, the goal is to outperform everyone else. Which is why your co-worker's eight year old is sure to win your office pool.

Lots of other cool stats over at BostonSportsHub

Update:

For those that really want to geek out, here is a table of all seed matchups going back the last 27 years pulled from mcubed.net.