Question about PE and bond yields

Question: Are not earning yields the inverse of PEs? If that is the case both are related except one is inversely related. Am I missing something?

The typical relationship I was referring to in a previous blog is the following.

The market rises when earning yields are greater than bond yields. I studied this relationship in depth and I did not find it reliable. There have been times, for instance, when earning yields were much greater than bond yields and the market performed poorly for a protracted period of time. Some analysts try to read too much in this relationship.

The relationship discussed in the blog below, on the other hand, is much simpler. It tells you whether the market is expensive or not. I find this second relationship more reliable keeping in mind it does not provide "buy" or "sell" signals.

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

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

History repeats itself

Who says history does not repeat itself?

The graphs of the stock market and bond yields keep following the historical script (click on graph to enlarge). The trick is to know which part of history follows the script.

I told you (see previous blogs) the rise in bond yields will be followed by a market decline. We are in the process of experiencing this event.

I also told you that a peak in the S&P 500 was going to be followed by lower bond yields. This is exactly what is happening.

What next? The peak in bond yields will be followed by a bottom in stock prices.

For those of you who read my book Profiting in Bull or Bear Markets this is the typical relationship you should expect between a leading indicator (the stock market) and a lagging indicator (bond yields).

The market bottom will take place when our indicators will become even more oversold. We are getting there.

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

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

Food for thought

If the dollar finds support at these levels we should expect:

a. Commodities to weaken (including gold).

b. Financial stocks to rally.

Time will tell.

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

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

PE and bond yields .... they are related

PEs and bond yields are related. But please, forget the popular earning yields and bond yields relationship! They are not related and the relationship is totally useless in forecasting the stock market. Unless you can prove it to me, of course.

The enclosed chart (click on graph to enlarge) shows a different relationship between yields and PEs. The relationship is based on more than 20 years of historical data.

a. The range of S&P 500 PE rises when yields decline.

b. The range of S&P 500 PE declines when yields rise.

The chart shows that when yields are close to 5% (as they are now), the market PE has ranged between 16 and 40. In other words, history shows that the market is relatively cheap with the PE close to 18 at the current level of bond yields. Of course, you can still have sharp corrections caused by the disastrous policies of the Fed.

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

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

Stock prices and bond yields....a reliable relationship

If you peruse this site, I have been explaining the relationship between stock prices and bond yields for some time. I like it because it is a reliable one. This is an update of what I said it would happen ..... and is happening.

a. Rising bond yields are followed by stock market corrections. Yields on the 10-year bonds have been rising from 4.50% in February and are now close to 4.80%. The typical lead from the bottom in yields to the top in stocks is about 3-4 months. And what happened?

b. The stock market is decisively declining. This is good news because the rise in yields is having its historically reliable effect of being followed by a peak in stocks. What next?

c. The decline in stock prices is followed by lower bond yields (and stronger bond prices). This is exactly what is happening right now. The time has come to make money in bonds. What next?

d. The decline in bond yields will be followed by a bottom in stock prices. The on-going decline in bond yields suggests the decline in stock prices is having the historically reliable effect of pushing bond yields lower. The decline in bond yields means that the stage is being set for the next market bottom. The bottom will happen when investors despair about the future.

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

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

Let's thank the Maestro for the mess we are in

The financial system is in the process of unwinding the subprime craze.

Losses in the U.S. subprime mortgage market were worse than Standard & Poor's expectations, according to an official of the rating company (Source: Bloomberg).

Investors are not buying the repackaged subprime bonds. Credit is shutting down. Liquidity is decreasing. M&A activity is dwindling.

This is a classic bubble in the process of imploding. And we have to thank Mr. Greenspan for this experience.

He lowered interest rates to 1% to cushion the 1999-2000 equity bubble (that also happened under his reign). How could he think that 1% interest rates would not create distortions?

The moral of the story is that we have to be very careful in acclaiming the wisdom of many political operators. Investors will lose a lot of money. Banks will have troubles that are just being recognized. Homeowners will lose the house they thought they could afford.

We are now in the midst of a credit crunch with investors not supplying the liquidity for the system to function. Bonds are not bought because rating agencies did not see the problem. Banks are trying to sell them and need to cut prices. Low grade bond prices are falling sharply to attract investors. Losses are piling up. Equities are sold to raise needed liquidity.

We need to thank the Maestro for the fine mess we are in.

The good news is that crises create investment opportunities.

The typical answer from the Fed will be to inject liquidity in the banking system to keep the system functioning and to lower interest rates. Bonds and stocks will rally and the stage is set for the next bubble.

I am a firm believer the weakness, or strength, of the dollar is the only gauge telling the health of the American system. Let's hope is going to strength real soon.

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

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

Question: will the subprime mess send the market down 5-10%?

I do not know. No one knows. Those who think they know have been dead wrong in the past!

I follow my models, my indicators and when they tell me the market is at an interesting buy point, I will recommend my readers to buy.

For the time being the trend of yields and stock prices is one of the relationships I follow closely (see previous blogs).

And besides, I like to talk about sectors. In this market some groups are sinking. Others keep going up.

My suggestion is to think asset classes, not "market".

Bonds, for instance, have been, and are, strong, as I suggested here. They have to strengthen significantly for the market to stop declining. We are getting there.

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

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

Bad news for the market

According to Bloomberg global corporate credit risk surged as concerns about accelerating subprime-mortgage losses caused investors to flee all but the safest assets.

Corporate bond risk rose to a two-year high in the U.S. and Europe, according to credit-default swap indexes that allow investors to speculate on the ability of companies to repay their debt or hedge against the risk they won't.

Indexes tied to the risk of owning high-yield, high-risk loans fell to records, suggesting demand is deteriorating for leveraged-buyout debt. Indexes of credit-default swaps on subprime mortgage bonds also plummeted to new lows.

The increase in risk is bad news for stocks. Especially financial stocks.

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

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

Do you want to make money in this market?

Which are the weakest sectors to short?

You guessed it. Those closely related to credit risk: real estate and financial stocks.

This is where you want to look if you want to short this ugly market.

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

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

Financials and dollar are sinking

I just cannot envision a strong stock market in the coming months with the dollar sinking to new lows and the financial sector in deep trouble.

It might be the first time this type of trends are associated with a strong market.

Is there somthing I do not see?

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

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

More news on the unwinding of M&A debt

M&A activity is going to slow down. A squeeze on liquidity is coming. Time to be cautious.

"JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said demand for leveraged buyout debt is drying up and banks may be left holding more loans that they can't sell.

There is ``kind of a little freeze in the marketplace,'' Dimon said on a conference call with investors to discuss the New York-based bank's second-quarter earnings. ``If you see this continue you will see the Street taking on a lot of bridge loans and more aggressive repricing of those things.''

JPMorgan, the third-largest U.S. bank, is among lenders that have been saddled with at least $11 billion of high-yield bonds and loans they haven't been able to readily sell, data compiled by Bear Stearns Cos. analysts show. Investors have balked at the increasing amounts of debt being taken on for LBOs (Source: Bloomberg)".

How will all the debt used in M&As unwind? This is bad news for financial stocks.

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

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

Mr. Bernanke and the dollar

In today's testimony to Congress, answering a question about the weakness of the dollar, Mr. Bernanke declined to comment because the dollar is responsibility of the Treasury.

Oh, come on Mr. Bernanke, with all due respect you know better than that.

The dollar is an exquisite variable reflecting monetary policy and inflationary expectations.

The sagging dollar is a vote of no confidence in our policies, especially monetary policy.

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

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

Crisis after crisis after crisis after crisis.........

We had an equity bubble in 2000 thanks to easy money in 1997-1998.

The Fed eased aggressively as the equity bubble imploded after 2000.

Interest rates close to 1% gave birth to the housing bubble, the subprime expansion, and the orgy of M&A activity.

The Fed raised interest rates to more normal levels (around 5%-6%) once they determined the financial markets were under control.

The outcome is the uncovering of the bubbles: housing, subprime, and junk bond financing of M&A activity.

What will the Fed do next? If the implosion of the three bubbles keeps unfolding you can rest assured they will lower interest rates. Especially if the equity markets tank.

And so we move happily from crisis to bubble to crisis to bubble ....

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

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

The beginning of the end?

A very interesting story by Bloomberg.

"July 17 (Bloomberg) -- Goldman Sachs Group Inc., JPMorgan Chase & Co. and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can't readily sell.

The banks have had to dig into their own pockets to finance parts of at least five leveraged buyouts over the past month because of the worst bear market in high-yield debt in more than two years, data compiled by Bloomberg show.

In most deals, investment banks promise to provide loans to the buyer. They then seek other lenders to take pieces of the loans and find buyers for bonds.

When buyers vanish, the banks must either buy the bonds themselves or provide a bridge loan to the borrower, tying up capital that would otherwise be used to finance more deals. The banks typically parcel out portions of bridge loans to reduce their risk.

Acquisitions by private equity firms such as New York's KKR and Blackstone Group LP helped push sales of high-yield bonds and loans worldwide up more than 70 percent during the first half of the year to a record $708 billion, according to data compiled by Bloomberg. High-yield, or junk, bonds are those rated below Baa3 by Moody's Investors Service and BBB- by Standard & Poor's."

Bottom line. The private equity funds borrow from the banks. Banks sell the bonds. Oops! Investors do not want to buy those bonds. Deals go sour. High-yield bond prices decline (this is happening right now, as I predicted). Banks are stuck with losses of bonds that cannot be sold.

This situation and the subprime debacle are classic credit crises creating great buy opportunities. Eventually.

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

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

The economy will strengthen...Implications for the markets

The economy will strengthen. This is what our proprietary leading indicators are suggesting.

You can expect commodities to continue to rise and the dollar to weaken.

Commodities are a way to hedge the lower dollar and our loss of purchasing power.

Foreign investors are buying US assets at a discount with their strong currencies.

Yes, the world is flat.

How long will continue? I am smelling a bubble. But let's enjoy for as long as it lasts.

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

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

Commodities and interest rates

Commodities are soaring across the board. Especially the metals.

This is a strong indication the economy is strong in spite of poor retail sales figures. Manufacturing is improving (see http://www.peterdag.com/) and proprietary indicators point to further growth head.

Interest rates cannot decline under these circumstances. Commodities, especially gold, need to be much weaker for this to happen.

Maybe this time is different. But I like to anchor my logic to historical and proven relationships.

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

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

Bond yields and stock prices

The stock market cannot rise without a more visible and convincing decline in bond yields.

Meanwhile, the stock market will remain weak.

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

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

Solid perspective from a respected economist

These are some comments by the chief economist of Bank of America.

a. The large US current account deficit and foreign accumulation of US debt will not unhinge the US economy as long as international trade and capital are allowed to flow freely.

b. Budget imbalances and current account imbalances do not move in tandem.

c. The US trade imbalances and large current account overseas have been the natural consequences in rates of economic growth, investment, and saving.

d. Decades-long worries that foreign investors will abruptly sell their US assets are misplaced.

e. The government's net costs of servicing debt owned by foreigners have been low and concerns are misplaced.

I would like to add that the two major issues facing the US are:

a. Protectionism.

b. Convince the American people that our role in the world economy is changing and we are now part of it with all the challenges and obligations this simple idea entails.

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

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

The global economy is in an upswing

The bearish feelings about the economy are grossly exaggerated.

I am tired to hear about the subprime crisis, the weakness of the housing sector, the death of the consumer, the weakness of the dollar, and how we are doomed.

The facts are quite different.

a. Employment is strong.
b. Income is strong.
c. Manufacturing is improving.
d. Commodities are strong.
e. Bond yields are rising.
f. The global business cycle has turned decisively up with the indicators of the 5 major Asian countries, the USA, Germany, UK, France, Canada, Brazil, Russia, and India pointing to strong growth ahead.

This is what you see when business conditions are red hot!

Let's stop crying that things are bad. There are great opportunities to make money in this environment.

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

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

Commodities, bond yields, and stock prices

Commodity and commodity sensitive stocks are rising quite sharply. Their trend has strong inflationary implications. Not coincidentally the dollar is weak and bond yields are rising.

These developments are bad news for the stock market. Stocks will rise sharply again when these trends are reversed.

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

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

Where are the bears?

The US economy has solid momentum.

Except for the unwinding of the housing bubble, the rest of the economy is doing well.

Income and spending are growing at a nice pace. Claims are at levels associated with solid employment growth. Backlogs are expanding at a double digit pace. Liquidity is growing at a rapid pace. The yield curve has steepened.

These are all positive signs suggesting the housing debacle is not having the feared impact on business activity.

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

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

The Fed has become irrelevant

The Fed is on hold. I do not think it matters much right now. The markets are taking over.

The US is providing liquidity to the world. This liquidity is recycled in part back to the US. And the world economy is booming.

Most of the money goes back to the UK, which is becoming a major player in the international financial markets.

This is the reason the Sterling is reaching new highs relative to the Dollar.

We are becoming less competitive even in the financial arena thanks to the obsessed Washington regulators.

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

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