Bailouts, bailouts and more bailouts. How much money is getting pumped into the economy? Trillions and trillions. (I'll try to find some good numbers on this.) Will this result in more inflation? Absolutely.
When? Ah, there's the hard part. For now, inflation is still the biggest risk as the price of everything from oil to plasma TVs is collapsing.
In the meantime, what should we do about it? Well, TIPS (Treasury Inflation Protected Securities) are the traditional way of protecting a fixed-income portfolio from inflation. Now, Treasury yields are at historic lows, so this probably isn't a good time to buy, but let's run the numbers now and then keep an eye out when things turn. (How bad of a time is it to buy Treasuries? The government recently auctioned some Treasury bills for 0%. That's right, zero. People were actually ready to pay the government to look after their money.)
TIPS pay interest every six months. The catch is, every six months, the government adjusts up the principal value of the debt based on the CPI. So although TIPS will yield a fixed interest rate, the principal amount will change based on inflation. So far so good.
Now, when is a good time to buy? Well, 10-years TIPS are yielding about 2.4%. Meanwhile, the regular 10-year Treasury bond is yielding 2.65%. We can't directly calculate that expected inflation is only 0.25%, but, we can safely say that the market is expecting inflation over the next ten years to be less than 1%. That I don't believe, and therefore wouldn't be a buyer of TIPS right now (or of Treasuries, for that matter).
Now if I were a hedge fund, I'd think about buying TIPS and shorting Treasuries, or just shorting Treasuries outright. I'm not a hedge fund guy, and I won't, but it's an interesting thought. But for now, it's time to sit tight.
Tuesday, December 9, 2008
Tuesday, December 2, 2008
Profits and GDP
Another interesting barometer of the market is what percentage corporate profits make up of total GDP. In a nutshell, when corporate profits are too high above the long-term average, look out.
The BEA (Bureau of Economic Analysis, part of the Department of Commerce) publishes both GDP and corporate profit statistics. A long-term chart of corporate profits/GDP shows the ratio at about 5% during the bad times, and around 6% during the good times. (For a good long-term chart, look at PIMCO's February 2007 Investment Outlook by Bill Gross.)
How about recent history? Well, profits/GDP ranged between 5%-6% from 1998-2002. Then things got out of line - 7.7% in 2004, all the way to over 10% in 2006 and 2007. (These figures from the BEA website, http://www.bea.gov/national/index.htm.)What did this mean to astute observers? (And I don't count myself as one, because I didn't realize this until after the crash!) Corporate profits were too high, were unsustainable, and had to fall - by as much as 50%, in order to return to historical norms. Ouch!
(As an aside, if we did some further math, we could probably have calculated that the excess corporate profits came from low interest rates and too much debt.) The moral of the story - watch the corporate profits/GDP ratio, and when it gets out of line, be careful.
The BEA (Bureau of Economic Analysis, part of the Department of Commerce) publishes both GDP and corporate profit statistics. A long-term chart of corporate profits/GDP shows the ratio at about 5% during the bad times, and around 6% during the good times. (For a good long-term chart, look at PIMCO's February 2007 Investment Outlook by Bill Gross.)
How about recent history? Well, profits/GDP ranged between 5%-6% from 1998-2002. Then things got out of line - 7.7% in 2004, all the way to over 10% in 2006 and 2007. (These figures from the BEA website, http://www.bea.gov/national/index.htm.)What did this mean to astute observers? (And I don't count myself as one, because I didn't realize this until after the crash!) Corporate profits were too high, were unsustainable, and had to fall - by as much as 50%, in order to return to historical norms. Ouch!
(As an aside, if we did some further math, we could probably have calculated that the excess corporate profits came from low interest rates and too much debt.) The moral of the story - watch the corporate profits/GDP ratio, and when it gets out of line, be careful.
Monday, December 1, 2008
Other valuation indicators
Today, a few other old-school but useful metrics for whether it's a good time to buy.
Corporate yield spreads: At the lowest, Baa corporate bonds were trading only 150 basis points over 10 year Treasuries. (Data from Bloomberg: .BAA10Y INDEX GP) They've shot up to 500 basis points now, going from extreme optimism to extreme pessimism. What does this tell us? That market is way out of whack - no surprise.
U.S. Treasury TIPS give us a sense of inflation expectations - right now they've plunged off a cliff, from pricing in ~2.5% inflation down to ~1%. (Data also from Bloomberg: USGGBE10 INDEX GP)
Another oldie but goodie: comparing dividend yields with the 10-year government bond rate. The 10-year government bond rate is 2.7% according to the Wall Street Journal - very low - while the dividend yield on the S&P 500 is 3.4%. (The 2008 expected dividend is $28.05, according to S&P's "S&P 500 Payers vs. Non-Payers" table. Dividing that into the 12/1/08 closing price of 816 gives us the 3.4% yield.) This is a return to a very long time ago, when the dividend yield on stocks was higher than interest rates due to the risks associated with stocks. Of course this was long forgotten in the 80s, 90s, and post-2000 in the long boom, but the fact that we're back here is telling indeed - the market is expecting a very, very, very bad ten years.
Corporate yield spreads: At the lowest, Baa corporate bonds were trading only 150 basis points over 10 year Treasuries. (Data from Bloomberg: .BAA10Y INDEX GP) They've shot up to 500 basis points now, going from extreme optimism to extreme pessimism. What does this tell us? That market is way out of whack - no surprise.
U.S. Treasury TIPS give us a sense of inflation expectations - right now they've plunged off a cliff, from pricing in ~2.5% inflation down to ~1%. (Data also from Bloomberg: USGGBE10 INDEX GP)
Another oldie but goodie: comparing dividend yields with the 10-year government bond rate. The 10-year government bond rate is 2.7% according to the Wall Street Journal - very low - while the dividend yield on the S&P 500 is 3.4%. (The 2008 expected dividend is $28.05, according to S&P's "S&P 500 Payers vs. Non-Payers" table. Dividing that into the 12/1/08 closing price of 816 gives us the 3.4% yield.) This is a return to a very long time ago, when the dividend yield on stocks was higher than interest rates due to the risks associated with stocks. Of course this was long forgotten in the 80s, 90s, and post-2000 in the long boom, but the fact that we're back here is telling indeed - the market is expecting a very, very, very bad ten years.
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