Longtime readers of mine — going back to the email days 10 years ago — will note that at various times I have been bullish or bearish (or both, depending upon different sectors). Regardless of our investment posture, there is always a good faith effort to maintain an analytical rigor and intellectual discipline in our investment approach.
This means sometimes discarding attractive theories, or embracing counter-intuitive ones. It also means questioning your assumptions, stress testing your theories, and whenever possible, having your ideas "peer-reviewed" to identify weaknesses or possible theoretical holes. Blogging has been very helpful in that regard.
That approach also means reading a variety of different viewpoints, theories, and people — most especially those who I may be in disagreement with; It forces a rethink of current principles, and keeps the reasoning process sharp.
Which brings me to a column on CNBC.com today. In it, Vince Farrell mentions towards the end:
"Jason Trennert, my oft quoted strategist, calculates that dividends on stocks
exceed the yield on 3-month Treasury bills. That has happened two other times in
the last 50 years and both coincided with major market bottoms."
That seems to be fairly reasonable on the surface . . . but after thinking about it for a few minutes, it struck me as potentially having some hair on it.
A little digging, and the flaws in the reasoning surfaced:
Start with where Real (not nominal) Rates are today: They are currently negative at 3.0%. That makes the 3 Month T-bill rather artificially low. That becomes a second variable worth reviewing: Does this buy metric — SPX dividends > the yield on 3-month Treasury bills — work when real interest rates are negative?
The quick test of this theory is to see when the last time Fed engineering might have pushed the 3 month rate below the dividend yield.
It turns out that they had done so recently. Indeed, the dividend yield on the S&P500 has been above the 3 month T-bill for quite a while now — since February 2008. (Recall the emergency Fed cuts made just prior to that). If you made any purchases on the basis of SPX Yield exceeding 3 Month T Bill, you ended up with some jumbo losers on your hands.
Hence, we must repeat our prior admonishment against relying on Single as opposed to Multiple Variable Analysis in making any market forecasts or buy decisions. More often that not, you can find varying degrees of correlation, but end up lacking a causation sufficient to make an informed investment decision.
I would suggest those who like to use this metric to rerun their analysis — but run a cross check with a 2nd variable of real versus nominal rates. You may find a rather a different set of results . . .
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S&P500 Yield (blue) Vs 3-Month Treasury Yield (red) against SPX (gray)
chart courtesy of Michael Panzner
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Previously:
Single vs. Multiple Variable Analysis in Market Forecasts (May 2005)
http://bigpicture.typepad.com/comments/2005/05/single_vs_multi.html
“A Whiff of Panic . . .” (January 22, 2008)
http://bigpicture.typepad.com/comments/2008/01/a-whiff-of-pani.html
Source:
Farrell: Touching Bottom in this Bear Market?
Vince Farrell
Jul.22 2008, 7:23 AM ET
http://www.cnbc.com/id/25794408/site/14081545
….yes and if you add in a few more variables like:
1. Consumer Debt
2. Uprecedented Real Estate Declines
3. Ongoing War
4. $10 trillion deficit
5. Etc.
You get an even different story. Yep, single variable correlations are dangerous.
Example: I asked a mortgage broker in 2006 at a small gathering: How can banks make loans without checking income?
“Well, they did an tudy and found that people with a high FICO rarely defaulted, so now we don’t need to spend all that time verifying incomes.” Righto buddy….
I guess when things are not going your way, single variable correlations are the only straws you can clutch at…. Barry, you are absolutely right, lots of money lost on that methodology….lots..
Dollar is taking off after Paulson’s speech this am..
The ‘bottom callers’ come out in droves, both early and often. But why should we ever listen to them – do any of them ever try to tell us when the market is topping?
We all know the answer to that one…
finally, no one is talking about a housing bottom now. for those who have been waiting with a growing family, time to go hunting this fall and next spring.
You’re listening to Vince Farrell? When was the last time he was correct about anything? Shouldn’t he belong with Ben Stein in the gallery of people who will use any stat to make their erroneous points?!
Vince Farrell ,Another one of Kudlows of Lap Boy’s. That says it all!!!
Vince, does seem to be a nice man, but he also tends to tout the party line. Let’s face it so many of the people working on wall-street are in the pocket of special interest. If JoeSixPack only knew the truth, we would have another bolshevik revolution. I think Democracy, like Communism in 1987, is having its darkest hour. Both because of the same reason – bureacratic capture, i.e. greed!
This metric of stock dividends being higher than the yield on the 91 day T-bill is another version of “don’t fight the Fed”. While that works most of the time, it didn’t work during 2000-2002.
Furthermore, I have heard Jason Trennert say that he is somewhat bearish on the market for 2009.
Finally, I have heard the permabulls say over and over the following:
“if you take out financials, corporate earnings look reasonably good”.
Now Vince Farrell is largely predicating his market call on the high yields that financials offer.
Lost in this discussion is the vulnerability of the single variable being analyzed. Currently the S&P Financial Sector has the 3rd highest median dividend yield. By this time next year Wells Fargo may be the only financial paying a dividend.
Another factoid:
In 1972, the dividend yield on the S&P 500 was 2.7%
According to “Yahoo finance” the t-bill rate on February 7, 1972 was 2.99%
The year 1972 was not a particularly good time to be buying stocks.
Consider the contra-positive of the claim that when 3 month T-Bills go below SPX return, is a low, and hence a good time to buy.
The contrapositive, and thus logically equivalent, is that when the 3Mo is way above the SPX is a bad time to buy. A quick glance at the chart shows that the late 70’s early 80’s stand out sharply in this regard. So… evidently buying the stock market in 1980 would have been… bad! hmmmm
In fact, again from the chart, it would seem that one should have been in T-Bills, not stocks throughout the 80’s, with a little maybe it’s a good time to jump in signal about 1992, but then quickly reverting through the rest of the 90’s and on into the 2000’s. Good luck with that investment strategy.
In fact, since we know what the yield maximizing strategy was during those times — Buy Stock — the graph presented seems to beg for precisely the opposite conclusion: This ain’t 1980.
Digging a little deeper, doesn’t the drop in T-Bill rates in the 2000’s have something to do with an attempt to prop up ‘the economy’, meaning more accurately ‘the stock market’. And doesn’t the current position on the chart also reflect a full bore effort by the federal government to bolster the stock market? These actions were motivated by? Crisis.
Sure, yeah, that’s a buy signal. Do please, go for it.
Damn, Barry, you beat the shit out of the guy! And with a smile, too! Go get ’em!
OK Barry, what planet are you from and what are you doing on this one?
No human being can so consistently defend his statements with logic and numbers. We humans rely almost exclusively on emotional appeal, bluster and/or intimidation to make our points, usually with a liberal helping of baloney.
Are you a Vulcan? Or are you surveying the planet for the impending hyperspace bypass?
~~~
BR: Just visiting!
Another Vince Farrell prediction…
Houston, we have a credibitity problem here.
Well, at least he is not calling for a bottom in real estate in this one.
You hit upon *****THE***** problem with Vince Farrell. He never digs down. He is always just shuffling surface numbers around. “5.5% unemployment isn’t bad.” “Washington Mutual selling off shares at $8. That’s a plus.” “-60K non-farm payrolls is better than expected, so the market can breathe easier.” “The Fed needs to maintain it’s strong dollar policy.” But as usual, the folks at TSCM will smile and nod and praise him whenever a comment looks to turn out okay and remain utterly silent when they (usually) don’t. Nice gig.
what about comparing say GE vs. the ten year, is there anything that can be concluded from such a comparison? otoh, it probably can help sell some stock and fill up time on the yak shows at cnbc.
vince farrell? next…