Three Short Articles

2012 March 28
by SJ Leeds

Today, I want to share three articles that I found interesting.  They involve:

1. profit margins (is the stock market expensive)

2. the FHA – the next housing disaster

3. an unbelievable article about student debt


Profit Margins

James Montier of GMO wrote an interesting piece titled, “What Goes Up Must Come Down!”  Here’s the link to their site.  Here are some of his key ideas:

1. U.S. profit margins are at record highs according to NIPA data.  See Exhibit 1.


2. It’s strange to see these record high margins during such a weak economic recovery.


3. GMO believes in reversion to the mean.  (Wall Street analysts, on the other hand, expect profit margins to continue to rise.)


4. I always think about total return as a combination of:

A. change in price/earnings multiple (it can contract or expand); plus

B. change in earnings; plus

C. dividend yield.


But, Montier broke it down a little bit more.  Instead of just using change in earnings (the second variable), he used change in sales plus change in margin.  (Change in sales and change in margins is the same as change in earnings.)  He argues that S&P 500 profit margins are currently 7.8% and should revert to 6% over the next seven years.


5. These are the assumptions that result in GMO’s estimate that real returns from stocks will average .4% for the next seven years.


6. He argues that the government deficit is the reason for the high margins.  Once the government slows its deficit, profits will drop.



Business Week published an interesting article this week, called “FHA Bailout Risk Looming Larger After Guarantee Binge”.  Here’s the link.  A few ideas from the article:


The FHA guarantees $1.1 trillion in home loans.  This has tripled (to $1.1 trillion) since 2007.   They have been counting on growth in home prices to rebuild their insurance fund.


Moody’s predicts that home prices will fall 3% in 2012 before growing 1.4% in 2013 and 6.5% in 2014.  The FHA used projections that called for increases of 1.2% in 2012 and 3.8% in 2013.


NYU Professor Andrew Caplin says that losses will be deeper than the FHA predicts because the agency uses a home-price index that excludes distressed sales.


By law, the fund is supposed to hold 2% of its portfolio in reserve.  As of September 30th, it held only .24%.  It has paid out $37 billion to cover defaults over the past three years.


Joe Gyourko of the Wharton School predicts that taxpayers will be on the hook for between $50 billion and $100 billion.


Student Debt

There have been loads of articles recently about the cost of college and the amount of outstanding student debt.  But, you need to read this article.  Student debt is starting long before college.  Here’s the link.


Have a great weekend.

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