Friday, September 07, 2007

Today's Jobs Numbers: CNBC Fans The Flames of Panic

Where does one begin on this topic?

First, the facts, so to speak. Today's non-farm payroll numbers came in so low that they recorded a net loss of jobs in the US economy recently. Expectations were for a much higher number.

The questions now on the table:

Is the US economy now in, or about to enter, a recession?
Has the Fed dithered in the face of obvious data requiring a rate cut?
Does Ben Bernanke now 'have mud on him,' as a CNBC on-airhead anchor so callously asked?
Will the Fed now cut the Funds rate later this month and by how much?

As I write this at 11AM, EDT, the equity markets are falling. The S&P500 Index is off by about 1.5%.

It probably will not help that CNBC is prominently featuring guests who are screaming that we are now in a full-blown recession. Among those CNBC chose to lead this ill-advised, partially-informed charge, is none other than their resident self-annointed know-it-all, Jim Cramer.

Cramer, a journalist and lawyer by training, has no bona fides in economics. Nonetheless, he was featured this morning on CNBC, loudly and confidently proclaiming that 'we've been in a recession for months.'

I'll believe it when Brian Wesbury and/or John Rutledge confirm it. But on Cramer's uneducated hunch? No, thanks.

Is it necessary, or even ethical, for CNBC to be featuring such uninformed babbling in the guise of news?

Throughout this morning's coverage, the anchorman named Carl (I can never recall his last name) and most of their guests continued to look for the darkest implications of the jobs number. Carl was the one asking several guests if this single employment number did not now sully Ben Bernanke's entire reputation as Fed Chairman?

The way I view this is as follows. A single month's payroll number is announced. Whereas, in years past, some experienced, educated and trained economists would work with the data to arrive at some tentative conclusions, now we have a world full of amateur economists, analysts, and investors all reacting at once to the news.

Remember, too, that roughly 90% of those hearing this news are less skilled at investing or analyzing than the top decile. But they may well control the movement of more money in financial markets.

Thus, we are probably in for several days, if not weeks, of poorly reasoned reactions by the vast majority of (mediocre) investors.

Are we genuinely in a recession? It's not clear yet. I read some interesting information in the Wall Street Journal today referencing some research out of Goldman Sachs. The work is based upon dividing the US into 20 regions, and forecasting recession based upon how many regions are simultaneously losing jobs. In the past, eight regions with shrinking employment led to recessions. Currently, as I recall the article, twelve are in decline.

Time will tell. On one hand, one payroll report does not tell all. On the other hand, as another CNBC guest noted, the monthly payroll numbers have been shrinking, though still positive, for a year.

It could well be that the Fed will cut the Fed Funds rate by a quarter, or even half a point later this month. However, now it's likely to be to cushion the pain of a softening economy, not simply to bail out New York and Connecticut hedge fund managers.

Who Wants To Compete with Steve Jobs & Apple?

After Wednesday's announcements, would you want to walk into the CEO job at a competitor of Apple's?

Let's review what just happened.

After only 2 months on the shelf, Jobs has slashed prices and increased capacity/functionality of the iPhone. This is not because the iPhone was a failure. This is Jobs and Apples putting the big competitive squeeze on their competitors.

How can you compete with someone who moves the yardsticks so significantly in so short a time? I'd guess that if the firm you joined as CEO had hoped to have a competitive phone out by Christmas, now you will toss it in the dumpster as already obsolete, in terms of price/performance.

Jobs is now racing down a value-added/volume curve, pricing ahead of current volume, and about to reap tremendous value-added from the market for new iPhones, iPods, etc.

Rather than bid down the price of Apple's stock, as sellers have effectively done this week, I think the price will ultimately head the other way. Once the mediocre investors have finished dumping the stock, and the wiser investors scoop it up at a cheaper price.

Sellers of Apple stock miss the big picture. The firm has quickly and consistently improved every element of its product lines- computers, music players, phones, and the new AppleTV. These are the actions of a strong competitor which is getting even stronger and more dominant.

So a few iPhone buyers got stuck paying a lot to be early adopters! So what? This is normal in the electronics sector. Being first with a new toy (remember the Apple Newton?) always means paying full list, and then some. Boo-hoo.

From Apple, they should expect rapid follow-on at better price/performance points.

Everything I see in Apple's broad new product announcements screams strength and improved sales and profits going forward.

This is classic, textbook Schumpeterian dynamics at work. Jobs is cutting the footing out from underneath his competitors as he introduces new features to Apple's products and raises the bar for what is now default performance.

Personally, I own one of the original iPod Shuffles. If memory serves, I paid $100 for a half-gig model. Now, a new Nano has several gig of storage, a video screen, and costs only $150. I'm seriously considering an upgrade, just because of this new product introduction.

You couldn't give me a job as CEO of one of Apple's competitors in phones or music players and/or online music purchasing right now.

Thursday, September 06, 2007

CEOs, Corporate Performance, and Houses

Yesterday's Wall Street Journal featured, as one of its three front page articles, a piece by Mark Maremont describing academic research into the relationship between various events and actions in the private lives of CEOs, and the stock price performances of the companies they headed.

The fact that this article was given such prominence tells you that the editors of the Journal feel it is important and reputable. Perhaps the most interesting and methodologically valid piece of research presented in the article was one by Yermack (Penn State) and Crocker (Arizona State) relating CEO home building and subsequent stock price performance of their companies. While it's worth reading the Journal article in its entirety, the short version of this particular research effort's result is to find that those CEOs who built/purchased large homes ( >10,000 sq ft) saw their companies' stock prices, on average, decline 25% in three years, while those with 'other' homes saw, on average, increased stock prices of roughly 20% by year three.

No measures of statistical significance were provided in the Journal article, although one surmises that one is available in Yermack's and Crocker's paper. Their approach was novel and inventive. They chose a single point in time, the end of 2004, and secured housing data on 488 of the S&P500 CEOs.

The basic premise being described, of course, is that of a CEO engaged in building or buying a large home is taking his mind and attention off of shareholders' welfare, and concentrating, instead, on spending his compensation on luxurious trappings of power. Among the CEOs mentioned in this manner, by name were: Leslie Wexner (The Limited), Stephen Bollenback (Hilton), and Trevor Fetter (Tenet Healthcare).

So far, so good...and simple-minded.

You see, there is another possible, and reasonable explanation for this phenomenon. But you'd have to be open-minded about observing and measuring corporate performance in order to see it.

My proprietary research has indicated that once companies have consistently outperformed the S&P500 Index on a total return basis for five or more years, the chances of this performance continuing falls precipitously.
Thus, a CEO building a large house with the fruits of her/his successful efforts at outperforming the S&P in the prior years would make sense. And the probabilities of continued outperformance would be slim, anyway.
Thus, Yermack and Crocker may have simply validated that succesful CEOs reap the rewards of their efforts for shareholders, and the game is over for a few years.
As I look at the nearby, Yahoo-sourced stock price chart of The Limited (Brands), Hilton Hotels, and Tenet Healthcare, all mentioned by name in the research piece, I draw a different conclusion than the study's authors.
To me, up through 2004, while the Limited struggled from 2000 onward, staying roughly even with the S&P, Hilton outperformed the index, and Tenet outperformed for about 4 years, then fell sharply.
Thus, I find Hilton and Limited to not be examples of the behaviors suggested in the Yermack and Crocker research. Tenet may be. It's declined has persisted since 2003.
The frame of reference you use, and what you know about potential corporate total return performance, matters in how you evaluate subsequent CEO behaviors after a period of good or great performance versus the index. I don't find the study that the Journal article spotlighted to be so bullet proof now as I did when I initially read of it.
Now, I would be very interested to know how their results would differ if they applied my knowledge of the probabilities of corporate consistently superior performance over time, versus the S&P, to their existing work.

Wednesday, September 05, 2007

The Union Picket Line: How To Explain This Anachronism?

It's funny how some things grow to be anachronisms, yet we don't stop to notice until someone else points it out.

For reference, Merriam-Webster's Online Dictionary defines anachronism as:

2 : a person or a thing that is chronologically out of place; especially : one from a former age that is incongruous in the present

The anachronism du jour is the union picket line. Let me explain.

Recently, the school which one of my daughters attends began construction on a new building. As a letter from the school's head noted, the construction contractor was selected on the basis of price and quality. Evidently, the lucky winner does not employ unionized operating engineers. We know this, because members of said union now constitute a small pair of picket lines across entrances to the school property which are used for construction materials, workers, and other school visitors.

Thus, throughout the long, hot summer, we have been treated to the sight of unkempt, largely overweight males standing, sitting, or sprawling on the nearby sidewalk, sometimes sporting signs which I have no doubt purport to explain their presence. On occasion, one of them dons a cloth suit made to represent a rat. On other occasions, a large, presumably inflatable rat is located at the other entrance.

I frankly didn't give all of this hoopla much thought, until my daughters each asked, independently, what this odd-looking display was on the sidewalk outside the nearby school, and why these men were engaged in this activity.

Thus it occurred to me that there no longer is a plausible explanation for these sorts of picket lines. Eighty years ago, they made sense. Not in my town today.

In order to explain what strikes and picket lines were supposed to do, I asked my daughters to think about what would have to happen for these anachronisms to have a function. Together, we discussed how local customers of the picketed business or institution would have to behave in such a manner as to support the striking union members, refuse to give their custom to the struck entity, thereby causing it to succumb to the union's demands.

Further, we discussed how this might work if: the community was experiencing significant unemployment; the union members were visible, known community members, too; the organization being struck was viewed as unfair or with some suspicion; the replacement workers were viewed as accepting, or known to have accepted unfairly low compensation, and; the unemployment of said union members had a significant effect upon the community at large.

None of these conditions obtains in the present situation involving the striking union members. They are, for the most part, from other towns or states. Nobody local to the school or neighborhood knows them.

It turns out that schools undergoing building projects are a favorite target of the operating engineers union. My business partner noted that they recently struck a public school in his nearby town when it, too, was doing new construction. Public and private schools are hardly the sort of organization you consider to be borderline criminal or shady when doing something like constructing new buildings. Further, the taxpaying residents and/or parents paying tuition to the relevant schools know they will be paying for the construction, one way or another. Thus, seeing union members striking might actually give them a feeling of comfort, that the price of the construction is not artificially inflated by absurdly high union wages and benefits.

Construction in this area continues to be very active, so it's likely that any competent laborer who wants to work at this trade is employed. At competitive wages. The striking, non-working union members, if anything, look foolish and incompetent. They refuse to take available jobs at good pay, choosing instead to spend their day sitting in the hot sun wearing silly-looking signs and/or animal suits.

Finally, since they don't live in the area, their unemployment has virtually no effect upon the local economy.

To sum up, there is zero support from the local populace for this strike. The picket line fits the definition of an anachronism. It's a tool from a bygone era.

Perhaps in the deepest Bronx or Queens, such a picket line might have an impact. Or in some smaller, poorer, more blue-collar rural town in a predominantly "blue" state.

But not in this upscale, economically well-off, predominantly white-collar town in which many residents commute into New York City to work in the financial services sector.

Thus, the image of scabs being physically assaulted as they cross the picket line at the school across the street from my home, resulting in news coverage of the conflict, is fantasy. The strike, and its picket line, is an exercise in futility.

What does this tell us about the mental capacity, sensibility, and awareness of modern times of the leaders of the local operating engineers union in my area?

Tuesday, September 04, 2007

An Apocryphal Tale: The Ten Best/Worst Days In Ten Years

There's an old aphorism with which I am acquainted that goes something like this:

"In any ten year period, if you miss the ten best days of the S&P, you'll lose half (or some similar value) of the return during the period."

To some extent, while the concept seems reasonable, I have treated it somewhat apocryphally.

Until now.

Last week, in the midst of the recent market turmoils, with various pundits calling for, demanding, expecting, etc., a Fed rate cut later this month, I thought it propitious to revisit this old tale.

Here's what I did. Using a daily adjusted S&P500 price series from Yahoo, I created a ten year series, from which I calculated daily total returns.

I then sorted the total return series by returns, in descending order.

For the ten years beginning August 29, 1997, the S&P500 statistics are:

6.5% average annual return

.03% average daily return

.05% median daily return

1.14% standard deviation of daily returns

+5.73% best daily return

-6.87% worst daily return

So far, so good. We see that the past ten years have, largely due to 2001-02, provided an average annual S&P500 return which is slightly more than half of the long term annual average return of 11%. The median daily return is above the mean daily return, informing us that the distribution of daily S&P returns is skewed positively. This is despite the worst daily return being lower, in absolute value terms, than the best daily return. The standard deviation of the daily returns, at 1.14%, is far greater than the mean or median daily return, indicating a very volatile daily value.

But, what about the aphorism that led to this ad hoc research? What are the returns of the ten best (and worst) days of the S&P over this ten year period?

+48.4% summed return of the ten best days of the S&P during the period

-48.% summed return of the ten worst days of the S&P during the period

This gives us:

65.2% summed actual daily returns for the S&P over the ten year period

16.8% summed daily returns for the S&P over the ten year period, without the ten best days

113.2% summed daily returns for the S&P over the ten year period, without the ten worst days

Each group of 10 days, best and worst, comprise approximately 74% of the ten years' summed total returns of the S&P. If we compare these two 'ten day' returns to the long run average annual S&P return of 11%, they comprise only +/- 44% of the total return of an average ten year period.

So, if we took a number of samples of ten year periods of the S&P, we might very well find that the aphorism is true. Something approaching half of the value of the S&P returns over a ten year period may be accounted for by just the ten best, or worst, days of the S&P over the period.

So what?

Well, it demonstrates how good your 'market timing' had better be, if you are a market timer. Miss a few days, either way, and you have an entirely different return than the market, even if you are only invested in the S&P500.

Frankly, it is simply stunning. At least to me. I can think of no other word.

To learn that missing only 10 out of some 2,500 days of S&P daily returns can remove between 50% and 75% of the total return of the ten year period confirms my belief that market timing is folly. Or making daily market calls, like Jim Cramer did this morning, on CNBC.

My own equity investment strategy approach distinguishes between markets in which we should be long, and those in which we should be short. Long term. Period. No attempts to predict daily, weekly, or monthly market moves.

Our equity strategy typically mirrors large daily moves in the S&P, but with larger magnitudes.

Now that our major focus is applying the equity strategy via long-dated, out of the money call options, this is doubly true. Although, relative to comparable S&P500 calls, it's not yet clear if this behavior extends to options.

Nonetheless, the validating of this little apocryphal tale heavily reinforces my belief in remaining invested, long or short, continuously, and abstaining from going to cash, unless very briefly, amidst noisy long term market signals.