Political Calculations
Unexpectedly Intriguing!
November 21, 2014

Friday, 21 November 2014 saw a major change in the expectations for future dividends per share in the stock market for the current quarter (2014-Q4), as measured by the Chicago Board of Exchange's dividend futures contracts, as not much changed for all of the other more distant future quarters for which we have data. Our first chart below shows the amount of quarterly dividends per share that are now expected to be paid out for the S&P 500 before the expiration of each dividend futures contract through the third quarter of 2015, which should be compared to our previous snapshot of these same expectations from two months ago.

S&P 500 Past and Expected Future Quarterly Dividends per Share, Snapshot on 21 November 2014

As a quick side note, the term mismatch issue that exists between the data reported by S&P and that indicated by the CBOE's contracts is such that we expect that the value for 2014-Q4 will be adjusted significantly upward at the expense of 2015-Q1 when S&P reports its data for the fourth quarter of 2014 early in 2015.

Using this data to calculate first the year-over-year growth rates of the S&P 500's trailing year dividends per share, and then the change in those growth rates from one quarter to the next, we can see the expectations surge for 2014-Q4, while the other future quarters don't change very much at all.

Change in the Growth Rates of Expected Future Trailing Year Dividends per Share with Daily and 20-Day Moving Average of S&P 500 Stock Prices, 21 November 2014

Since investors have been largely focused on 2014-Q4 in setting stock prices since the Fed's October meeting, stock prices rose significantly on Friday 21 November 2014, and very soon after the market opened, they peaked at 2071.37 before finally fading to close at 2063.50, just 10.75 points above its previous closing value.

S&P 500, Alternative Futures, 2014-Q4, Standard Model, Snapshot on 21 November 2014

As best as we can tell, the one thing that caused investors to suddenly focus on 2014-Q4 and to adjust their expectations for the amount of dividends that S&P 500 companies would pay out for the quarter was China's central bank's surprise action to cut interest rates to stimulate that nation's slowing economy as it approaches recessionary levels.

Normally, that sort of thing wouldn't amount to much more than what we would describe as a noise event, where the change in stock prices would be relatively short-lived, but this noise event coincided with a change in the fundamental driver of stock prices. That makes it unlike the minor speculative boost in U.S. stock prices following a merger announcement in the biotech industry earlier in the week. And as such, it is a rare example of how noise can actually contribute to the efficiency of setting stock prices, although as we've observed in previous examples, its contribution is most often rationally inefficient.

Now let's throw some chaos into the mix. Right now, investors are very much focused on 2014-Q4 in setting today's stock prices. But the quarter is more than half over, so the key question is how long will that continue? They will soon have to shift their forward-looking focus to some other point of time in the future.

That's where the recent improved expectations for the current quarter can come back to bite. Since the outlook for the other future quarters that investors have to select from did not improve, and because those outlooks are, at present, largely negative, the boost in stock prices today will set up a larger decline in the future when the attention of investors does shift.

And how big that decline will be is something that will itself be determined by the expectations associated with the alternative future points of time that investors might choose to focus upon next.

The best outcome would be if investors focus upon 2015-Q2, which is something they might be prompted to do if the Fed more clearly indicates that it will boost short term interest rates in that quarter.

The intermediate outcome would be if investors have reason to return their focus to 2015-Q3, which is something they might do since that's when the Fed last indicated it was likely to boost those short term interest rates.

And the worst outcome would be if investors suddenly had reason to focus upon 2015-Q1.

Programming Notes

We're following our annual tradition of focusing almost entirely on the Thanksgiving holiday all next week, but we'll find a way to tie in stock prices in some way, shape, manner or form before the week is over. And turkeys. Probably together in an incredibly unlikely way!

And now, you can't say you weren't warned!

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November 20, 2014

Needless to say, the secret to superior paper aerodynamics requires precise fabrication! (HT: Kottke)

The paper folding tool shown in the video is surprisingly affordable, as is the bag clip!

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November 19, 2014

Every three months, in the middle of each financial quarter, we've been taking a snapshot of the earnings per share for the S&P 500 that are expected going forward for as far as Standard & Poor projects them. In our last installment, we saw that there had continued to be a large amount of erosion in the expectations for stock market earnings in future quarters.

This time however, it would appear that the outlook for future earnings has stabilized, which would be a positive development.

Forecasts for S&P 500 Trailing Twelve Month Earnings per Share, 2010-2015, Mid-2014-Q4

We see that there has been some minor erosion in the very near term, or rather, the expectations through the end of 2014-Q3, which are still being reported, but we see that there has also been some minor improvement in the expectations for quarters following 2015-Q1. Overall however, the most significant takeaway from the changes since August 2014 is how little the expectations of future earnings per share have changed during the last three months.

Still, it's a good time to point out, once again, how volatile the expectations for the S&P 500's earnings per share are over time. It's a good thing that the expectations for these earnings have so little impact upon stock prices!

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November 18, 2014
U.S. Mexico Border Region - Source: http://www.mchb.hrsa.gov/MCHIRC/dataspeak/events/july_08/materials/notzon_files/textonly/slide4.html

The southern land border of the United States with Mexico is 1,954 miles, or 3,145 kilometers, long. The U.S. government has established a total of 670 miles of fencing, spanning 34.3% of the length of the border.

In many ways, the U.S.' Mexican border fence is just the most recent and visible barrier established between the two nations. Its history dates back to the Carter administration, which initiated the fence in response to a government bureaucrat-created "crisis":

In this context, federal resources for boundary enforcement increased significantly, starting in the second half of the Carter administration with a focus on California, where local and state officials were making the most noise in favor of a border crackdown. There, the federal government installed a 10-foot-high chain-link fence along the seven westernmost miles of the divide, backed by floodlights and increased helicopter patrols.

After that initial effort, known as the "Tortilla Curtain," not much happened until increasing border enforcement to stop people from crossing into the U.S. from Mexico became a major priority for the federal government once more during the Clinton administration.

Seeking to repay the labor unions that provided critical political support during the 1992 elections, newly elected President William Clinton initiated a series of border enforcement operations aimed at preventing Mexican migrant workers from competing for U.S. agricultural industry jobs, beginning with Operation Hold the Line in El Paso, Texas in 1993.

That initial effort was followed by Operation Gatekeeper in San Diego, California, Operation Safeguard in southern Arizona and Operation Rio Grande in Brownsville, Texas over the next four years, where the increased border enforcement activity greatly increased the costs for individuals seeking to unlawfully cross the border into the United States. Princeton's Mexican Migration Project has documented the cost of unlawful border crossings during President Clinton's tenure in office from 1993 through 2000, which increased exponentially from approximately $750 in 1992 to $2,000 in 2000:

Princeton MMP - Border Crossing Costs, 1980-2012

These costs primarily represent what human smugglers, popularly known as coyotes, charge Mexican and other foreign nationals to get across the U.S.-Mexico border and past U.S. border patrol agents. In addition to human smuggling, coyotes often engage in other criminal activity, such as drug trafficking and bribery, and have a history of employing bloody acts against their competitors and law enforcement officials.

The exponential increase in border crossing costs decelerated with the election of President George W. Bush, who was sworn into office in January 2001. However, the costs that foreign individuals pay human smugglers to enter into the U.S. has continued to increase steadily, largely due to the increased border security measures that the U.S. adopted in response to the terrorist acts of 11 September 2001.

Border Fence Under Construction - Source: http://www.cbp.gov/newsroom/photo-gallery/photo/2013/11/southwest-border-fence-construction-progress-7

On 26 October 2006, just ahead of the elections in which the Republican party would lose its majorities in Congress, President Bush signed the Secure Fence Act of 2006, which mandated the construction of 850 miles of reinforced fencing along the border. That was later reduced to 670 miles of reinforced fencing by the Consolidated Appropriations Act of 2008, which was approved by the Democratic party majorities that had taken control of the U.S. Congress after the 2006 elections, which was ordered to be completed by 31 December 2008.

In 2008, the average amount that human traffickers made in smuggling people across the U.S.-Mexico border into the United States was $2,500. Between 2000 and 2008, the criminal cost of entry into the U.S. had increased at an average pace of $62.50 per year.

Through the end of 2012, with those 670 miles of reinforced fencing in place, the cost of illegally crossing the U.S.-Mexican border into the United States has risen to approximately $3,000. With just a limited amount of reinforced fencing in place, the criminal cost of entry into the U.S. has increased at an average pace of $125 per year, double what it was when active border enforcement operations were the only impediment in place to the unlawful activity.

Back in 2008, we had actually proposed building what we have, a partially fenced border, for the purpose of further increasing the cost of unlawful entry into the U.S.

We now have the means to completely undercut the coyotes' human smuggling business. If the U.S. government were to now allow foreign individuals to enter into the U.S. after they pay an entry bond/work visa of $1,200, or 40% of what human traffickers charge, they can nearly completely cut the criminal element out of the picture.

Why set that value at 40% of the criminal cost of entry into the U.S.? The idea here is to allow at least two people to be able to lawfully enter into the U.S. for less than what the coyotes charge for one, which would thoroughly undercut their criminal human trafficking enterprise. Border security officials would then be able to focus their efforts upon the purely criminal activities at the border, because there would be no longer be any reason for honest people with no intention of engaging in any other criminal activity to continue to associate with the coyotes.

At the same time, the cost is high enough where it would not lead to a border-crossing free-for-all.

The entry bond/work visa would also provide a source of revenue for deporting the fraction of those foreign nationals who outstay their work visas, while at the same time providing for their replacements in the U.S. labor force.

The question now is are the immigration reform wonks smart enough to adopt the rest of our plan for dealing with illegal immigration?

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November 17, 2014

Today, we're testing out a super-simple method for dealing with short term echoes for our standard model for forecasting stock prices.

Echoes, as our long term readers will know, are the result of past volatility in stock prices and their effect upon our forecasting model. Because our forecasting model incorporates a number of historic stock prices in the math underlying the model, from time to time when there is a larger than typical amount of volatility in the historic data, it can result in deviation between our model's projections and the actual trajectory of stock prices. The chart below shows the base reference points in the historic data that we've used for our standard model's projections throughout 2014.

S&P 500 Index Value (Historic Data Base Reference Points) Used in Standard Model Forecast Projections, 2014

We've previously focused our efforts on those situations where the echoes of past volatility were present for a sustained period of time, which we dealt with by simply rebaselining our model to more distant base reference points in the past, which proved to be very successful. We could most certainly do that again, but we wondered if that wouldn't be overkill for the situation where there is an echo present in the data that simply won't be around for such a long period of time.

For echoes with durations of just a few weeks or less, we wondered if we could just simply draw a straight line to bridge across the gap corresponding to the echo effect upon our forecasting model. And since we have just such a situation happening right now in the stock market, thanks to a short, sudden correction from a month ago, which is coincidentally one of the base reference points we use for making our projections of the present, we thought we'd try it out.

The results are presented in our alternative futures chart below. Here, we observed that stock prices were following the trajectory associated with investors being focused on the current quarter, 2014-Q4, in setting current day stock prices. We then identified the next point in time in our projection for that trajectory that would be outside of the echo effect. And then we connected the dots....

Alternative Futures for S&P 500, 30 September 2014 - 6 January 2015 (Standard Model - Incorporates Historic Stock Price Data for Projections from One Year Prior) - Snapshot on 14 November 2014

So far, so good. We'll see if stock prices continue to behave that nicely during this week, which we also think will be increasingly unlikely as time progresses forward.

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