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Understanding How to Analyze Market Metrics

Posted By Barry Ritholtz On July 22, 2008 @ 11:58 am In Dividends,Earnings,Investing,Markets,Quantitative | Comments Disabled

Longtime readers of mine — going back to the email days 10 years ago — will note that at various times I have been bullish or bearish (or both, depending upon different sectors). Regardless of our investment posture, there is always a good faith effort to maintain an analytical rigor and intellectual discipline in our investment approach.

This means sometimes discarding attractive theories, or embracing counter-intuitive ones. It also means questioning your assumptions, stress testing your theories, and whenever possible, having your ideas "peer-reviewed" to identify weaknesses or possible theoretical holes. Blogging [1] has been very helpful in that regard.

That approach also means reading a variety of different viewpoints, theories, and people — most especially those who I may be in disagreement with; It forces a rethink of current principles, and keeps the reasoning process sharp.

Which brings me to a column on CNBC.com [2] today. In it, Vince Farrell mentions towards the end:

"Jason Trennert, my oft quoted strategist, calculates that dividends on stocks
exceed the yield on 3-month Treasury bills. That has happened two other times in
the last 50 years and both coincided with major market bottoms."

That seems to be fairly reasonable on the surface . . . but after thinking about it for a few minutes, it struck me as potentially having some hair on it. 

A little digging, and the flaws in the reasoning surfaced:

Start with where Real (not nominal) Rates are today: They are currently negative at 3.0%. That makes the 3 Month T-bill rather artificially low. That becomes a second variable worth reviewing: Does this buy metric — SPX dividends > the yield on 3-month Treasury bills — work when real interest rates are negative?

The quick test of this theory is to see when the last time Fed engineering might have pushed the 3 month rate below the dividend yield.

It turns out that they had done so recently. Indeed, the dividend yield on the S&P500 has been above the 3 month T-bill for quite a while now — since February 2008. (Recall the emergency Fed cuts [3] made just prior to that). If you made any purchases on the basis of SPX Yield exceeding 3 Month T Bill, you ended up with some jumbo losers on your hands.

Hence, we must repeat our prior admonishment against relying on Single as opposed to Multiple Variable Analysis [4] in making any market forecasts or buy decisions. More often that not, you can find varying degrees of correlation, but end up lacking a causation sufficient to make an informed investment decision.

I would suggest those who like to use this metric to rerun their analysis — but run a cross check with a 2nd variable of real versus nominal rates. You may find a rather a different set of results . . .

S&P500 Yield (blue) Vs 3-Month Treasury Yield (red) against SPX (gray)

Dividendandtbillyield [5]

chart courtesy of Michael Panzner [6]


Single vs. Multiple Variable Analysis in Market Forecasts [4] (May 2005)

“A Whiff of Panic . . .” [7]  (January 22, 2008)

Farrell: Touching Bottom in this Bear Market? [2]
Vince Farrell
Jul.22 2008, 7:23 AM ET

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2008/07/understanding-how-to-analyze-market-metrics/

URLs in this post:

[1] Blogging: http://bigpicture.typepad.com/

[2] CNBC.com: http://www.cnbc.com/id/25794408/site/14081545

[3] emergency Fed cuts: http://bigpicture.typepad.com/comments/2008/01/feds-folly-fool.html

[4] Single as opposed to Multiple Variable Analysis: http://bigpicture.typepad.com/comments/2005/05/single_vs_multi.html

[5] Image: http://bigpicture.typepad.com/comments/files/dividendandtbillyield.PNG

[6] Michael Panzner: http://www.amazon.com/exec/obidos/ASIN/141959608X/thebigpictu09-20

[7] “A Whiff of Panic . . .”: http://bigpicture.typepad.com/comments/2008/01/a-whiff-of-pani.html

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