Last September I was bearish on Delta Airlines (DAL), saying “How quickly we get from something that looks enticing to something that looks like it came out of bankruptcy five months ago. Which, of course, it did. Bottom line, if you want to take a flier on an airline, I’d stick with one of the short squeeze plays. The majors still look like they can cause a major league stomachache.”

Earlier this month, I noted that I should learn to take the money and run, as three of my previously correct bearish calls had been bolstered by takeover rumors.  With Delta now solidly back in the column of not making me look stupid, it’s time to call it quits on this call.

U.S airlines plunge on recession worries | Markets | Markets News | Reuters

Shares in U.S. airlines plunged on Wednesday, with Northwest Airlines (NWA) and Alaska Air Group (ALK) dropping more than 10 percent, after JP Morgan cut its ratings on those carriers and several others due to recession concerns.

Since my original bearish article, Delta is now down 37.3%, compared to a 10.3% decline in the S&P 500 (SPY) over the same period. Although I didn’t take a financial position in the stock, I am figuratively closing the position. Before another greater fool comes along and tries to buy them out, I’m taking the money and running.

Disclosure: At the time of publication, William Trent has no financial position in the companies mentioned. 

Conventional wisdom holds that magazine cover stories are contrarian indicators - by the time a company’s success or failure reaches the cover page of a major publication the story is so well known as to be completely reflected in the stock price. Therefore, all good news is priced in and the stock can only underperform or all bad news is priced in and the stock can only outperform.

While simplistic, the magazine cover indicator now has the support of recent academic research. This research did find that cover story headlines on Business Week, Fortune and Forbes tended to indicate that the mood (bullish or bearish) of the story had run its course in the market.

As a result of this research, I have decided to develop a portfolio of stocks based on using those three magazine’s covers as a contrary indicator. I also track this portfolio on StockPickr. This week’s results:

Forbes.com - Forbes Magazine Table Of Contents
Money For The Masses
Larry Light
Branch-heavy BofA leads rivals in retail deposits (also overall deposits), ATMs and card balances, which reap fees and interest.

Contrarian take: Stay out of financials, especially BofA. But you knew that already.

Risk returns - with a vengeance

For years big players ignored obvious dangers and reaped rich rewards. Now they are paying for their recklessness, and so is everybody else.  (more)

Contrarian take: Long everything. Risk premia, we hardly knew ye.

My watch lists did not perform as well as the benchmarks this week. The Small Cap Watch List (Track at Marketocracy) lost 2.54%, compared with losses of 2.25% for the Russell 2000 and 1.59% for the S&P Small Cap 600.

The Mid Cap Watch List (Track at Marketocracy) lost 1.96%, compared with 1.32% for the S&P Midcap 400.

The Large Cap Watch List (Track at Marketocracy) lost 1.43% while the S&P 500 lost just 1.19%. At least it is still doing better since inception.

The economic data last week continued the prior trend - mixed with a skew to the weak side.

EconomicData

The Watch Lists generally performed in line with their respective benchmarks this week.

The Small Cap Watch List (Track at Marketocracy) gained 0.5%, compared with gains of 0.4% for the Russell 2000 and 1.05% for the S&P 600.

The Mid Cap Watch List (Track at Marketocracy) gained 0.88%, slightly worse than the 1.09% gain for the S&P 400.

The Large Cap Watch List (Track at Marketocracy) gained 1.39%, more or less in line with the S&P 500’s 1.44%.

The Small Cap Watch List (Track at Marketocracy) only gained 0.21% this week, compared to 1.86% for the S&P Small Cap and 1.54% for the Russell 2000.

The Mid Cap Watch List (Track at Marketocracy) did slightly better, gaining 0.73% compared to a 1.42% gain for the S&P Midcap.

Fortunately the 2.28% gain for the Large Cap Watch List (Track at Marketocracy) bested the 1.67% for the S&P 500, which kept me from being swept.

It seems like everywhere I turn I hear about how the bond market is in control, and the stock market is just tagging along for the ride. And this is true, to the extent that stocks and bonds in general are falling in price (rising in yield).

But there is one aspect of the relationship I haven’t seen explored, which is that of the risk premium, or the extra amount investors want to be compensated in exchange for taking a certain risk. There are many risk premia, among them:

1. The higher rate normally required when tying up money for a longer period
2. The higher rate for corporate bonds as opposed to treasuries, in compensation for the risk that the company defaults.
3. The risk premium (typically manifest as growth) investors receive for investing in stocks rather than bonds.

There are many more, but I’ll focus on these three basic ones. The first one in particular was nowhere to be found in recent months, because the yield curve was inverted. You got paid more to invest short-term than long-term. The rise in interest rates that has so spooked the market has merely flattened the curve. Interest rates could go significantly higher before this relationship could even be considered “normal.”

As interest rates for treasuries have risen, so too have those for corporate bonds - though by a bit less.  Since March the yield on 10-year treasuries has risen from 4.53% to the current 5.02% - a total of 49 basis points. The Seasoned Baa corporate bond yield, according to the Federal Reserve, has risen 43 basis points from 6.19% to 6.62% during the same time period. The difference in rates, called the Baa/Treasury spread, is the risk premium investors require for accepting the risk of corporate default. It has fallen from 1.66% to 1.60%.

The current 1.6% spread is toward the low end of the historical range, unless you want to go back to the 1960’s. Even then, it is below average.

What does this have to do with equities? After all, this blog’s tagline is “Our beat: The Stock Market. Our job: Beat it.” It is fair to ask why I am spending so much time on interest rates. Well, for one thing the equity risk premium logically ought to fluctuate with the Baa/Treasury spread because riskier equities tend to have more corporate debt. And it turns out, the two are related.
Take a look at the major peaks and troughs on that yield spread chart. The highs (2002, late 1987, 1982 etc) tended to mark good times to buy stocks. The lows (the late 1990’s, the late 1970’s and 1973 among them) were often bad times to buy stocks.

It isn’t the level of interest rates, or of P/E ratios, that should concern investors but the potential changes in interest rates and P/E ratios.  Right now investors are willing to accept smaller rewards for each unit of risk they will take. There is a limit to this willingness, and when it turns investors will see how interest rates can really drive stock returns. I hope to have plenty of ammo available the next time the Baa/Treasury spread jumps above 3%, because I’m pretty sure that will be a good time to buy stocks.

The Small Cap Watch List (Track at Marketocracy) lost 0.7% this week, but that knocked the socks off the 2.49% decline in the S&P Smallcap and the 2.12% loss for the Russell 2000. It also allowed the watch list to pull back even with the S&P small cap on a cumulative basis.

The 2.84% loss for the Mid Cap Watch List (Track at Marketocracy) was a bit worse than the 2.45% loss for the S&P Midcap, making its cumulative lagg even worse.

The Large Cap Watch List (Track at Marketocracy) was the real stinker, though. It lost 3.11% against just 1.87% on the S&P 500. Even that did not eliminate its cumulative outperformance, though.

The watch lists will get a quarterly refresh at the end of the month.

The Watch Lists all posted gains this week, but for the most part they fell short of the more impressive gains posted by the benchmarks.

The Small Cap Watch List (Track at Marketocracy) gained 1.49%, but the Russell 2000 and S&P Small Cap both did better than 2.8%.

The Mid Cap Watch List (Track at Marketocracy) gained 1.26% against a 2.84% gain for the S&P Midcap.

The Large Cap Watch List (Track at Marketocracy) gained ground, however, rising 2.58% against just 1.36% for the S&P 500.

My personal holdings are still bringing up the rear.

First-quarter growth weakest in over 4 years - Yahoo! News

U.S. economic growth in the opening quarter this year was the weakest in more than four years as businesses sold off inventories and Americans imported more foreign goods, the government reported on Thursday.

Tell me about it. There wasn’t much to like in the report.

Growth in corporate profits is evaporating. Given that the reasonableness of current P/E valuations is dependent on the historically high “E” this should concern stock market participants.

Corporate profits also, not surprisingly, tend to be correlated with business spending on technology. Hopes for a Microsoft (MSFT - Annual Report) Vista-inspired tech spending resurgence appear to have been dashed. While bulls argue that lower profits will require tech investments to spur productivity, the recent trend is for companies to do more with less. Therefore, I’d argue that there will be a smaller share of the smaller profit pie going to tech.

While consumption spending did rise as a contributor to GDP, the drag on profits may mean more layoffs are in the pipeline, which in turn could put pressure on that consumption.

I’ve said before that betting against the American consumer is always a long-shot. At the same time, though, I’d be inclined to at least hedge any bet on continued strength.

As I hoped, the watch list performance rebounded some as the earnings season slowed down.

The Small Cap Watch List (Track at Marketocracy) gained 1.74% this week, easily beating the 0.69% and 0.76% posted by the S&P Small Cap and Russell 2000, respectively. Since inception it still lags the former but is ahead of the latter.

The Mid Cap Watch List (Track at Marketocracy) lost 0.45%, slightly trailing the S&P Midcap’s 0.21% loss, but it maintains a narrow edge since inception.

The Large Cap Watch List (Track at Marketocracy) was a hair above breakeven for the week, which was enough to beat the 0.46% loss in the S&P 500 and maintain its cumulative edge.

The legacy watch list continues to lead the S&P 500, while my own holdings are still bringing up the rear. Why didn’t I just buy one of the Watch Lists?