6/28/07

More on PE and bond yields

Question. I guess you have to ask how the low bond yield squares with the ever accelerating commodity prices in USD, and the tight labour market.

Answer. Bond yields reflect all the variables you mentioned. They are interconnected and represent the same issue. Rising commodities, a weak dollar, rising wages, low productivity growth are all aspects of inflation.

The main determinant of yields is the inflation premium. Stable/low inflation implies stable/low yields. You can rest assured that PEs will decline as inflation rises (which is the most likely trend).

The historical relationship I discussed in a previous blog shows that below average yields are associated with above average PEs. I must add, for those more technically oriented, that the relationship between bond yields and PE is non-linear.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Questions and answers

Question
Dear Dr. Dagnino,
In this cycle, I see that the stock prices peak during step 1. When will they start their decline and continue to decline?
I am confused because step 3 again shows that the lower bond yields are followed by higher stock prices.

Answer
Turning points are sequential. This is very important, although it sounds simple.

The market is weak because yields have been rising. This is event number one.

The market will continue to decline as long as yields rise. This is also an important trend. The market cannot rise without a prolonged decline in yields. Yields are still heading higher. So, let's be patient and wait for the right conditions to develop.

At some point in the future you will start seeing a decline in yields. One week. Two weeks. Something serious is happening. The market may be close to a bottom.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

Is the market close to a bottom?

I do not think so.

I am watching closely the trend of bond yields. Their trend never fails to provide useful information about the stock market. In the near and long term.

On page 5 of The Peter Dag Portfolio I show how lagging indicators (e.g.bond yieds) and leading indicators (e.g. stock market) interact.

A rise in yields raises the cost of money. Investors sell stocks to increase the liquidity they need for their investments. They will continue to sell until yields decline enought to make it more attractive to borrow.

This is the time when they stop selling stocks and the stock market rallies.

What I am saying is that you need to see a convincing decline in bond yields before you can look for a market bottom.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

6/19/07

Bond yields and stock prices

I found this useful pattern between bond yields and stock prices. It can be recognized over a period of 6-12 months.

  1. Rising bond yields are followed by a peak in the stock market.
  2. A peak in the stock market is followed by lower bond yields.
  3. Lower bond yields are followed by higher stock prices.
  4. Higher stock prices are followed by higher bond yields.
  5. Go to 1.

Right now yields are rising. We are in step 1. above. They will continue to rise until the market shows a visible decline.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portolio
Since 1977

6/18/07

The economy will strengthen. This is the good news.

Our proprietary leading indicator of business activity points to a stronger economy in the second half (see graphs, click on the chart to enlarge).

Those economist predicting "hard landing" are going to be shamefully wrong.This is the good news.

The bad news is that a stronger economy will have a major impact on inflation, commodities, and long-term interest rates.

This, of course, is not a pretty picture for some sectors of the stock market. Others will strive.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

6/7/07

The dollar is down 30% since 2002

The weakness of the dollar is worrisome and it justifies exposure to commodity sensitive stocks. It is the only way to hedge the loss of purchasing power caused by its weakness. The weakness of the dollar is a systemic issue.

We should be worrying less about how to regulate our lives, and more on how we can become accepted and welcomed by the global community. The world is changing in a dramatic way. Yet, we are isolating ourselves in everything we do. I might be wrong, but as an individual born in Europe and lived there for many years, I have the feeling I am in an island (although marvelous) very distant from the rest of the world.

We think we are a great country. And maybe we are right. But we should try to reach out and make the world part of ours. Not conquer and destroy. We should be part of what is happening, without being too ostentatious and seeking to be recognized for what we believe in. The rest of the world resents it.

More on www.peterdag.com

George Dagnino PhD
Editor, The Peter Dag Portfolio
Since 1977

My investment process

Managing money is a process involving continuous decisions which have to be taken at the frequency suited to each investor. Every week, every month…you decide.

The first step is to determine the investment scenario and evaluate which assets classes are most likely to benefit. The outcome of this step is usually a multiple set of scenarios. Start with the one with the best odds. The lower probability ones will also be used.

The second step is selecting stocks for each scenario. If the main scenario reflects a strong economy, then a high percentage of your portfolio should be in commodity-sensitive companies. If one of the scenarios is a slower economy, then some money should be allocated to, for instance, financial stocks.

The third step is allocating money to each stock reflecting the odds of success assigned to each sector. A chart showing the graphs comparing the price of all the stocks is an invaluable aid. Capital should be allocated according to the relative strength and financial appeal of each stock as it compares to the S&P 500.

The fourth step, probably the most important, is to evaluate the performance of your portfolio by looking at the change in the balance of your portfolio and at the chart showing the relative performance of your stocks. You have to decide how often you want to do it.

Are you making money? Is most of your money in the strongest sectors and the strongest stocks? What are the scenarios you are considering? You need to change your portfolio according to this new evaluation.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

6/2/07

Profits keep slowing down


Not a pretty picture.

Profits after tax are growing more slowly (click on graph to enlarge).

This trend has negative implications for the economy and for the stock market. Time will tell.

Question: will the Fed allow short-term interest rates to rise when profitability is reflecting a serious slowdown? I doubt it.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

6/1/07

Is the market too high?












The QQQQ is close to an important resistance line (in red).

I am watching closely the rising trend line (in blue). A violation on the downside could signal the beginning of a much needed consolidation (as in January-July 2006).

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977