Relevant and even prescient commentary on news, politics and the economy.

Not-So-Select Short Subjects

Now that I know we’re just members of the “Peanut Gallery,”* let this random links post work as a placeholder for longer posts as we prepare for the “holiday”:

Shorter Mark Thoma at Marketwatch: If you can’t build a better model, best to reappoint a man who doesn’t think he has to do half of his job. (UPDATE: Or even less than that. [h/t Linda Beale])

Shorter Mark Thoma at his own blog: All of our current models prefer people to starve and die.

A fun graphic (h/t Abnormal Returns)

Think the Health Insurance “Reform” Bill will “bend the cost curve”? Think again.

*That the “Periodic Table” pretends to be about Finance Bloggers and yet categorizes DeLong, Thoma, and Mankiw, to name three, as “Rocket Scien[tists]” instead of Economists should in no way be seen to impune the quality of the analysis, of course.

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Ratings, Stocks, and Credibility

There is a reason I never believe people who judge the health of a company by its credit rating: the evidence isn’t there, and everyone in the market knows it isn’t there.

Here is a prime example: General Electric (GE; the company that Jack eviscerated) has a AAA credit rating. It is also paying a 31 cent per share quarterly dividend.

The stock is trading at $12/share as I type.

That’s a yield of 10.31%, per MarketWatch.

The 30-year Treasury, as I write (presumably the Friday close) is yielding 3.32%.

Rounding off—I doubt anyone would seriously quibble the basis point—we have an allegedly-AAA company whose stock is trading 7.00% above Treasuries. At a time when the average “redemption yield” for investment-grade bonds is 6.47%.

Now, in sane circumstances, people would be saying, “Oh, but that’s because GE will, certainly, cut its dividend. And investors know that.” However, CEO Jeffrey Immelt (the man charged with cleaning up Jack’s mess, who instead compounded his predecessor’s actions) assured investors that the dividend will not be cut, even as he noted that GE expects an “extremely difficult” 2009.

Moody’s has GE on credit watch with “outlook negative,” but they’ve only been there since 13 January 2009. This is a company that is paying about 15% of its net earnings out in dividends. Calling GE “not a growth stock” is like calling Sears anything other than a real-estate play: so bloody obvious that it shouldn’t need to be said.

Yet, for some reason, it needed to be said. And Moody’s is hanging there, ten days into “outlook negative” while the bleeding stock market is screaming “junk bond yield” on the equity.

Don’t get me wrong; GE is probably still investment grade. Their store credit card business ownership of NBC and affiliates consumer products division defense contracts alone should keep them there. But that’s what we said about GM too.

GM stock, which is the downside risk cited by MarketWatch, is currently yielding 28.5%. If General Electric (GE) were yielding that level with the current dividend, it would be priced around $4.35—about another 64% decline. [As noted in the comments, GM has suspended its dividend and actually yields nothing; the MarketWatch site for some reason reports the yield based on the suspended dividend anyway. -ATB]

If you’re asking me, this points the way to a good piece of the other part of the “equity premium puzzle.” But more on that in a later post.

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More on Presidential Administrations

Via Kathryn (who previously pointed us to a similar exercise for the U.S. election), Theo Gray expands on the work of Tommy McCall (as published in the NYT under the title “Bulls, Bears, Donkeys, and Elephants,” which was glibly dismissed by Greg Mankiw*).

While his conclusion will be heartening to Brad DeLong:

And one more thing, notice the little gray figure labeled “Current value under Both”. That’s the figure if you had just left your money in the market the whole time regardless of party affiliation. Notice that it’s much bigger than either the Republican or the Democratic figure. Not a bit bigger, much bigger, so much bigger that if you check the box to graph the “both” curve (basically the index value itself) we have to let it go right off the scale in order to make the other two lines visible at all.

Play with the policy delay slider and you can see the Democratic and the Republican curves fighting it out in the noise at the bottom of the graph while the steady-as-she-goes full-time investment curve towers over them laughing at their silly antics. It doesn’t matter who is in charge, the market is saying, in the long run it’s going to be OK.

the whole thing is worth reading, especially as Mr. Gray has sent the model up so that you can “playing with it” yourself.**

*We might justly ask Mr. Mankiw to then justify several of his Very Public Statements about the value to the market provided by the Current Administration when he worked for them. But that is for another time.

**I hope to do the playing maybe this weekend, by which time I might expand the details of this post. Meanwhile, I note that The Skinny Brown Man has made an interesting start by putting it into a much larger context.

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Let’s Play a Game: Connect the Dots

Let us assume:

  1. That there is an equity premium ([PDF] UPDATE: Link modified to Brad De Long posting in which the PDF is embedded. Hat tip: Don Lloyd in comments.)
  2. That the equity premium can be derived from a linear relationship (y = ax(1) + bx(2) + ….) of the most significant variables.
  3. That equity premia are, to some not-insignificant extent, based on Wealth Inequality [PDF].
  4. That one of the primary variables contributing to the premium is the reliability and quality of the information provided

Given the above, should we expect the imminent weakening of U.S. accounting rules, discussed here and here, to produce a higher equity premium?*

If so, there are two possibilities. Either,

  1. the firms are perceived to have a higher present value, despite the change being one of accounting, not business flows or
  2. the stock prices decline in the face of greater uncertainty, leading to an increase in the premium due to a lowering of the price.

My instinctive answer—which I can probably be convinced is wrong, but it would take some effort**—is that the second would be the result. Leaving only one question:

Why does Christopher Cox (R-CA) hate the Securities Markets?

*Following from [3] above, we can assume that greater information tends to result in more optimal investment practices, and therefore a lower equity premium.

**The argument would have to show that the loosening of accounting practices will result in improvements to the company’s business processes that would not otherwise occur.

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