(PUB) Investing 2016

The trend in the size of the gap between the market’s earnings yield and the Treasury yield gives some indication of whether stocks are losing their advantage over bonds or not. You can see that in the late 1990s: When stocks, led by the techs, moved into bubble-pricing territory, the market’s p-e was so high, and its earnings yield was so low, that bond yields actually looked super attractive. What we now know is that bonds ended up being a great place to put your money, because when that bubble burst, stocks cratered. The market’s earnings yield fell below the bond yield in Q2 1999. By the time it had gotten more than a frac- tion over the bond yield in Q3 2001, the stock market had dropped 21.5%, while the bond market was up 21.7%. Of course, the stock market didn’t hit bottom until late in 2002, but the fact is that while the earnings yield to Treasury yield gap isn’t a market-tim- ing barometer, it does give some sense

pared to the wintry slowdown of 2015, though we won’t know that until well into May or June. So you might think I’m pretty neg- ative on the idea of earnings prop- ping up stocks. But let’s look at the interest-rate side of the ledger. With their fairly punk yields, bonds aren’t exactly providing steep competition. The 10-year Treasury’s yield ended 2015 at 2.27%, up just 10 basis points, or 0.10%, from the end of 2014. It’s not surprising, then, that the total return on the 10-year was only 1.0%, which was just shy of the 1.2% gain for 500 Index , for example. One way to look at the competition for investor dollars from stocks and bonds is to compare bond yields with the stock market’s “earnings yield,” which is the level of earnings being produced for each dollar of stock value. (For those who want the specifics, this is the inverse of the market’s price- earnings, or p-e, multiple.)

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earnings (the price you pay for a stock is a call on the earnings and cash flow from the company issuing the shares) and interest rates (since bonds, with their virtually guaranteed payouts, are strong competition for investor dollars). We won’t know just how compa- nies fared in 2015 until the books are closed and financials are massaged to meet, beat or retreat from expectations. But through the third quarter of 2015, after-tax profits, which are probably the best and broadest measure of how companies big and small have done this year, have fallen 8.2% compared to the third quarter of 2014 (which was, I should note, the peak earnings period in this long, drawn-out expansion we’ve been in). Earnings comparisons probably won’t be too pretty in Q4, but they might surprise in Q1 2016 when com-

PUNDITS Ear-Plug Approved

1.5% growth (wrong—the 12-month gain through Q3 was 2.2%), that 10-year Treasury yields would drop below 2% again (half wrong—they were there for a nanosecond in October) and the dollar would weaken (way wrong; see page 3). He had plenty of other predictions, and virtually all of them were wrong, but his calls that “Brazil and Argentina [would be] the best performing emerging markets” and that “a military coup in North Korea [would lead] to civil war” were almost laughable. It’s not as if last year’s winners, the Wall Street herd, didn’t deserve a follow-up award. At the end of 2014, Barron’s asked 10 of “Wall Street’s top strategists,” who hailed from places like JP Morgan Chase, Goldman Sachs and BlackRock, their predictions for 2015. Their targets for the S&P 500, for instance, ranged from 2100 to 2350, which, given when they made the forecasts, translated into gains of 5% to 18%. As you know by now, the S&P index fell 0.7%. Oops. Morgan Stanley’s Jorge Kuri, director of equity research for Latin America, was a lot closer to being on the money, calling for 10% declines on a dollar basis for Latin America and saying his firm was underweight to Brazil (a smart move). Byron Wien, a former Morgan Stanley strategist who still gets ink with his predictions each year, said the S&P 500 would rise 15%. He also said Vladimir Putin would resign as lower oil prices deepened problems in Russia. I don’t have to tell you why he’s a former strate- gist. And I always like to reserve space for the 2013 Roubini Award winner, A. Gary Shilling, who is so consistently wrong that I can’t figure out how he keeps getting people to write up his musings. In late 2014, he asked

“With over 50 foreign cars already on sale here, the Japanese auto industry isn’t likely to carve out a big slice of the U.S. market.” — Business Week, August 2, 1968 OVER THE YEARS, I’ve tried to give you an honest take on where my year-ago thinking was right and where it was flawed. This year, you can find it in the box on page 12. Yes, I get some things wrong, and I fess up to them. On the other hand, I don’t make wild or speculative predictions, because I’ve learned a very good lesson from watching how wrong some of Wall Street’s biggest mouthpieces are year after year after year. Let’s start with my annual Roubini Award , named for the playboy economist who, as I’ve said, has called more recessions than the Boston Red Sox have won World Series, in a much shorter period of time. Last year, I handed the award to the collective of Wall Street analysts predict- ing ever-higher interest rates, which failed to come to pass. This year, I think JP Morgan Private Bank’s Richard Madigan deserves the Roubini Award for his hedged bets in the article “Possible Market Surprises for 2015,” published in Barron’s . In that piece, he said that “possible doesn’t mean probable,” which I take to mean he’s willing to predict stuff just so he can say, “I told you so,” if he’s right, but still has an out if he’s wrong. As it turns out, Madigan’s predictions were way, way off the mark. Right off the top, Madigan said U.S. growth would stall and pull back to

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