Are S&P’s Ratings Biased Toward Clients?

Note: I wrote this on Feb 2nd 2009 but never got around to publishing it. Still seems relevant, though. I stated my long position in MW on Motley Fool back in Feb, and have stated my short positions in SPG here and there.

After evaluating two stocks recently, and comparing their S&P ratings, I’m more convinced than ever that S&P ratings mean crap and are biased towards clients. Let’s take a look.

S&P has a sell on Men’s Warehouse (MW), who is not an S&P client, because of the “rough retail environment”. Yet they have a strong buy, 5 Star, rating on the highly-leveraged mall REIT Simon Properties (S&P client). Yes, I pick on SPG a lot, and yes, I’m short their stock. But I’ve already done the research, so might as well use it as an example. Here are some fundamental stats on the two:

Men’s Wearhouse: 8 P/E, 0.07 debt/assets (very little debt), strong cashflow, should perform pretty well in a downturn because people are looking for a deal. Current price: $11.75, S&P target: $11

SPG = 25 P/E, .75 debt/assets (it’s actually higher if you look at the sec filings instead the “balance sheet”. Joint ventures have a flattering effect on balance sheets). Faces a horrific next few years because of retailers, especially pricey ones. And they just switched their dividend to 90% stock (aka, they cut the div 90%).

No, this isn’t an apple-apple comparison. I had already done the research on SPG, so I just threw it in there. They’re both exposed to overall retail spending in a big way, so I figured it was close enough to make some comparisons. Plus, SPG has been a 5-Star S&P Strong-Buy pick since $105 or so. It’s currently around $32, and ramping down.

This whole thing just reinforces what Bill Fleckenstein has taught me – Analysts on the whole are biased and reactionary. They react to how a stock behaves, and adjust their price targets and recommendations based on these movements. They don’t really do much forecasting or meaningful research. There are exceptions, of course.

Moral hazard, or plain-old thievery?

The NY Times just published a very interesting piece titled The Looting of America’s Coffers. It’s about two economists who published a research paper called “Looting”. That was 16 years ago, and it was about the financial busts of the 1980s. The authors argued that the perpetrators knew very well that the whole scheme was a house of cards.

However, they were able to make so much money so quickly that it didn’t matter. It didn’t matter if the crap loans they wrote were ever paid off. They only needed to hold up for a few years before collapse. Then the government and the Fed would step in, and conveniently cover all the losses at the expense of taxpayers. By that time the perps were set for life.

Drawing a comparison to today’s situation is hardly necessary. But politicians won’t make any changes without us demanding it. Here is the form to contact your local congressmen. Please do:

Tell them to support Ron Paul’s bill to audit the Federal Reserve. Tell them to get some real economists in the treasury, not any more goddamn investment bankers or puppets like Geithner. Tell them to reveal the AIG counterparties. IT’S OUR MONEY THEY’RE WASTING.

Do NOT ask them. Tell them. If they don’t do what you ask, inform them that you will vote against them and actively campaign for any opposition if they don’t. We need to get a lot more pissed off than we are.

China’s economic influence is skyrocketing

China’s in a pretty sweet negotiating spot right now. Europe and America need their cash to finance rescues/bailouts/stimuli. Their once-lackluster sway over western nations is suddenly through the roof. This was especially evident today, when Chinese Premier Wen Jiabao said they are “worried” about holdings of Treasuries and wants assurances that the investment is safe.

That’s a scary statement. It’s highly unlikely that they’d dump large amounts of dollars and/or US bonds. That would cause a flood of selling and crash of the dollar, which would suck for everyone. But if they just stop buying debt, that alone could be a catastrophe. The only thing the dollar has going for it is that the Euro and British pound are also in trouble, and arguably worse-off.

It kind of reminds me of the US after WW2. Europe and Japan were destroyed, and desperately needed cash to rebuild. We loaned a lot of it to them. Then we emerged as the Superpower, with influence and power that dwarfed another nation’s. China’s rise won’t be as quick and drastic as ours was, from what I’ve seen. But power does seem to be inevitably shifting eastward.

Stocks still expensive according to Ben Graham model

According to this Bloomberg article, Ben Graham would still find US stocks to be expensive:

Benjamin Graham, the father of value investing and mentor of Warren Buffett, would find most U.S. stocks expensive even after the Standard & Poor’s 500 Index dropped 56 percent in 17 months.

Mr. Graham’s valuation method measured stocks against a decade of earnings to “smooth out distortions. Interesting, but I’m not sure if I understand the impact of it:

Graham measured equities against a decade of profits to smooth out distortions, a method that shows the S&P 500 trading at 13.2 times earnings, according to data compiled by Yale University Professor Robert Shiller. At the bottom of the three worst recessions since 1929, the average ratio fell below 10. To reach that level, the S&P 500 would sink another 27 percent.

Take it with a grain of salt, but it is interesting to see how valuation methods have changed over time.

Another interesting snippet from the Bloomberg piece:

“A lot of earnings estimates on which the market valuations are based are quite suspect,” said John Carey, who oversees $8 billion at Pioneer Investment Management in Boston. “You have to adjust what you see out there for reality. I remember thinking that a stock selling at 10 times earnings was expensive” in the 1970s and 1980s, he said.

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