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Strategies & Market Trends : Roger's 1998 Short Picks -- Ignore unavailable to you. Want to Upgrade?

To: Lazlo Pierce who wrote (5000)	3/16/1998 2:16:00 PM
From: Oeconomicus	Read Replies (1) \| Respond to of 18691

David et al, re the "Fed Model", a few comments: While I think comparing the earnings yield to 10 year treasury rates, if that's really all there is to the model, is overly simplistic, Yardeni makes a very important point. Yardeni says stocks look even worse than the Fed model indicates because he believes profits on the S&P Index will be hard-pressed to hit the current estimate of $50.78... "I think we'll be lucky to do $48. If you use $48, the market is about 25% overvalued," Yardeni says. Last year, operating profits for the companies in the S&P hit about $45.50. To reach $50.78 for this year, profit growth would have be 11%. Given that earnings are expected to rise less than 5% in the current quarter, an 11% gain for the entire year may be a tall order. Isn't First Call now saying 3.7%? Also, if you look at reported earnings rather than assuming away all the accounting games, trailing earnings on the S&P 500 have actually been declining. In mid-Feb, Barron's was reporting S&P earnings at $41.56, dropped it to $40.25 on Feb 20, $39.89 on Mar 6, and again this week to $39.77. Perhaps a lot of companies booked supposedly non-recurring charges in Q4 and will be able to show better profits this year as a result, but we are now at a market PE of over 27 and if the accountants have to play games with last year's numbers to show only lackluster growth this year, then even Yardeni's 25% figure understates the problem. My second comment pertains to Peter Canelo's argument in the article. His view: "You're not getting paid enough to be in bonds right now." Canelo looks at several measures that suggest stocks look good vis-a-vis bonds. One is the yield on the 30-year Treasury bond relative to the 1.5% dividend yield on the S&P. That gap, now 4.4 percentage points, is low by standards of the past 20 years, meaning that bonds don't offer that much extra yield. He says this margin has ranged from 3.5% to 9.5% since the early 1980s. A narrow gap favors stocks. Before the 1987 crash, the spread was over seven points. If a 3.5% spread between div yields and treasuries is the low of the historical range, isn't it then feasible that we could return to that spread. To do so would mean either treasury yields could go to 5% or div yields could go to 2.4%. In either case, bonds would outperform, but in the latter, the S&P 500 would need to be at about 663 or 38% below current levels. Actually, I don't think his yield gap measurement makes any sense anyway partly because the math just isn't that simple and his use of the div yield instead of earnings yield creates the gap and makes it kind of an apples and oranges comparison. Also, his historical period does not include a period were nominal bond yields, inflation and earnings growth were all low at the same time as they are now. In fact, the only environment during the period that he could have found a gap of 9.5% was the high inflation, high nominal yield environment of 1981. Mid-'82 was a great time to buy stocks, but the gap was still huge. It doesn't follow, logically, that when the spread is narrow, that's also a good time to buy. I'll go with what the Fed model tells us. Bob