December 2014 – S&P/TSX Composite Market Strategy Update

Everything you learn and read about financial markets seems so wishy-washy (call it subjective).

I’m a black and white sort-a-guy (and an accountant) and when it comes to dollars and cents my question has always been can’t the field of finance be more…. objective?

If you’re like myself…and why wouldn’t you be… then Model Price Theory [MTP] is made for you.

Welcome to the world of black and white!

And speaking of black and white, Canadian equities are in a BEAR market and that’s not being wishy-washy, it’s OBJECTIVE!

The last BEAR market in Canada was in 2007-08, and man, it was a doozy! I will be sporting those market scars for sometime. (See my blog “10 Things I Did in the Crash of 2008; That I Didn’t Do in 1987 and 2000”) However before I go into what a BEAR markets means for investors let’s review what transpired, in terms of market action, since my last blog (November 6, 2014) on the S&P/TSX Composite.

As a reminder here is the model price chart I included on my November 6th blog.

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines).

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines).

I stated in this blog:

The first negative transit is usually the market testing or whether the index belongs in a lower zone, in this case between EBV+1 and EBV+2. Again, in general, the market (I’m talking about indices here) usually rallies above the EBV Line it just negatively transited.

And sometime later – could be months/quarters another negative transit will occur confirming the initial negative transit.

THIS SECOND NEGATIVE TRANSIT WOULD CONFIRM THAT THE CANADIAN MARKET HAS ENTERED INTO A BEAR MARKET.

Well, guess what…. we had a second negative transit!

Here’s a current view of the S&P/TSX Composite Index.

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines).

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines).

 

And it was a sneaky negative transit that occurred on December 4, 2014, which was a Thursday. I notified members of the Model Price community on Facebook through the following comment:

From the 'Comments Section' from the Model Price app on Facebook

From the ‘Comments Section’ from the Model Price app on Facebook

 

Friday, December 5, 2014 was also an interesting day that looked peaceful on the surface but according to Model Price Theory [MPT] the Canadian market through the S&P/TSX Composite Index communicated to those willing to listen. I wrote the following comment on Facebook:

From the 'Comments Section' from the Model Price app on Facebook

From the ‘Comments Section’ from the Model Price app on Facebook

And the following week, the week of December 8th to the 12th, the S&P/TSX Composite was down in round percentage numbers 4.5% (see model price chart above).

What This Means To You as Investors

Gravity will have an impact on all asset values (share prices) in Canada even top quality or respected big corporate names we can all list off the top of our heads. For those who know Model Price Theory [MPT] selling stocks that have a negative transit is a must, even those respected corporate names we all know. Investors must be vigilant about all Canadian shares to ensure loss of capital is kept to a minimum.

Where are we going, in terms of the Canadian equity market? Not sure! But until we see positive transits both in individual stocks and the S&P/TSX Composite Index I would be cautious with a healthy cash balance and wait and see where this market wants to go. I’m reminded of the great quote by Yogi Berra, “It’s tough to make predictions, especially about the future.” A negative transit is a negative transit meaning an investor should act accordingly, the future can take care of itself with or without my (and your) capital.

Conclusion

Model Price Theory [MPT] is giving you ‘objective’ information. ‘Black and White’ info that only an accountant would love. Yes, we are in a BEAR market in Canada but that’s not the end of the world. As I have said in previous blogs, you can make money in a BEAR market, it’s just you have to redouble your energy, efforts and your discipline if you choose to participate.

When I come to the office everyday, my first question of the day is: “What market are we in”? Up until last Thursday, December 4th, the answer was always “We are in a Bull market”! Now that answer has changed and I’m judging myself accordingly.

Hope you are as well.

December 2014, S&P 500 Market Strategy Update

I guess everyone sees what is going on in the global equity world.

The US equity market, by all consensus including everyone at a cocktail party I went to last Saturday night, is the global equity market of choice. Yes, of course everyone is bullish and I’m sure investors are shifting portfolio allocations as I write this.

And yes, this is making me extremely uneasy.

We calculate a six-year total rate of return on our US equity mutual fund, Acker Finley US Value 50, on the front screen of our website, here. And on selected days we are up 250% over a rolling six-year period on recent days the market closes, handsomely outperforming our benchmark, the S&P 500 Total Return Index in Canadian dollars. Can we do any better? I don’t think so.

In other words, the fundamentals of the US economy, especially with falling energy costs and ever increasing US dollar, haven’t been this good for a long time. As my cocktail banter shows people see what’s going on here. Yes, the U.S. equity market has figured out this good news a while ago and has accordingly priced these improving fundamentals with ever increasing share price valuations while the market bears were yelling “Bubble!” And people being people they are lining up for the returns that have already happened!

As usual in these monthly blogs, let’s have a look at our Model Price chart on the S&P 500 Index to see what is going on.

S&P 500 Index with weekly price bars andEBV Lines (colored lines).

S&P 500 Index with weekly price bars andEBV Lines (colored lines).

 

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2206) this would represent a gain of some 7%. If the market corrected back to EBV+3 (1764) investors would be suffering losses of almost 14%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

Squeezing Up to the Top of EBV+4

The next few quarters are usually very strong, seasonally, for US equity share prices. And I do expect the S&P 500 Index to squeeze up to EBV+4 giving equity participants more equity gains over the next little while. This shouldn’t be hard to imagine as worldwide investors (especially Japanese and European investors) evaluate rates of return on global assets and seeing their portfolio equity returns in US dollars will simply say to their respective financial advisors, “Gimme more of that!”

Risk versus Return

As I have said previously, the S&P 500 Index can float between EBV+3 and EBV+4 without consequence according to Model Price Theory [MPT]. However there is a big difference in the risk/reward scenarios if the Index is closer to EBV+3 than EBV+4. I would caution U.S. equity investors’ that as the S&P 500 Index pushes closer to EBV+4 the more investment risk investors are taking with their US holdings.

Conclusion

Everyone now sees the US equity market as the market of choice, in terms of rates of return, for the next few quarters at least. At the same time as the S&P 500 Index pushes towards EBV+4, investors are taking on an increasing amount of risk with limited upside return, assuming EBV+4 is the maximum valuation level this market will achieve (and this will be a future blog post for sure!).

For investors who have been in the US market since the market bottom of March 6, 2009, it has been one hell of a ride. (From EBV+1 to a little under EBV+4, so far!) Unfortunately new investors hoping to capture any of these huge index gains of the past will be sadly disappointed. I’m not predicting doom and gloom here but just pointing out the obvious…returns will be lower with a much higher risk levels for those first timers eagerly throwing their capital in US equities at this time.

CPG – Having an Adult Conversation about Crescent Point Energy – Reblog

Thought this blog that I wrote on Crescent Point back in April, 2013 was worth a re-blog. A lot of pain out there on this one, and from my weekend reading investors still hopeful Crescent Point can still meet its distribution obligations. Hope this blog answers some questions and gives everyone who was invested in CPG pause for thought. The proverbial writing was on-the-wall on this one and with the fall in oil prices since September only enhances the weak fundamentals that were clear, at least to us!

This blog has two objectives.  The first is to highlight the valuation divergence currently underway between our model price calculation and CPG’s stock price.  The second objective is to discuss why we use Net Income or earnings for our valuation analysis instead of cash flow per share.

Valuation divergences occur all the time in financial markets especially with individual equities.  Where the fundamentals and the market price of an individual stock price can go in opposite directions for whatever reason.  These divergences can correct themselves, with fundamentals changing positively or the stock price correcting to the appropriate valuation level without warning, so investors have to be vigilant.  Model Price is a service that calculates valuation, model price or fair market value, for over 2000 companies using the same company data for our algorithms.  No special treatment is necessary or special calculations for individual companies.  Also divergences can last for a prolonged period of time.  Timing when divergences can disappear is very hard to predict.

Sometimes a picture is worth a thousand words.  So let’s start with a picture.  Here is the long-term chart of Crescent Point Energy.

Crescent Point Energy with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Crescent Point Energy with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

This model price chart displays our calculation of model price over the last 7 1/2 years.  After peaking in mid-2007, model price or our calculation of fair market value has steadily fallen over the last six years.

So what’s going on here?

Crescent Point Energy finally issued their 4th quarter and full year results on March 14, 2013.  I have downloaded the most recent financials, just as I have done with every annual report filed by CPG for the last few years.  This is fun reading for me.  Nothing like getting into the numbers, the balance sheet and don’t forget the all-important notes to the financial statements.

Three Reasons Crescent Point is notable!

First, the company clearly had a model price valuation either above its stock price – see chart above – or in the neighborhood of CPG’s trading value back in 2006 to 2009. Over time, since 2009, our model price calculation has eroded with no impact on the share price of CPG.  The gap in our calculated model price and CPG’s actual share price is getting wider as time goes on.  The market doesn’t seem to notice or doesn’t seem to care about this widening valuation gap.

One has to wonder why this is the case?  Doesn’t the market recognize the deteriorating fundamentals of the company’s earnings per share?  Certainly other Canadian oil companies have seen their share prices erode over the most recent past.  (Suncor and Imperial Oil are examples of this)  Are investors so enamored with the company and its annual distribution of $2.76 paid monthly that oil industry fundamentals are ignored?

Second, CPG has repeatedly paid investors distributions in excess of earnings for the last 4 years as I highlight in the table below.

2012 2011 2010 2009 2008
Cash Flow/Share 4.69 4.80 3.48 4.08 4.72
Net Income/Share 0.58 0.73 0.09 (0.19) 3.74
Distributions 2.76 2.76 2.76 2.76 2.61

The third item of note is the amount of shares Crescent Point has issued in the last two years.  The company has issued some 171 million shares!  At an average price of say $40 CDN, that’s a cool $6.8 billion of market value.  These shares were issued for company acquisitions and secondary offerings to investors.  CPG had a market capitalization at the end of 2009 of some $8.3 billion.  CPG’s market cap has grown to $14.8 billion as at mid March 2013, without a material change in the company’s share price!

Are you with me so far?

Let’s get into the current numbers and our model price chart.

Crescent Point Energy with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Crescent Point Energy with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

For those interested, a daily updated chart of CPG subsequent to this post will be maintained on Facebook, here.

As you can see we have calculated model price or fair market value of CPG to be $21.25 as at the close on April 9, 2013.  This is a 43% discount to CPG’s stock price of $37.67.  We use expected earnings estimates to determine the fair market value for every stock included in our database comprising of some 2,000 securities including CPG.  At the time of our calculation CPG had a mean earnings estimate for 2013 of $0.56.

Positives on Crescent Point

Are you shocked!  Yes there are positives.

The first positive is the company’s solid execution of production, which was ahead of consensus.  For instance, in this latest quarter – 4th quarter – production was 108,007 boe/d ahead of consensus of 102,000 boe/d.  This increase in production drove funds flow, highlighting …

… The second positive, again in the 4TH quarter funds flow came in at $1.18 and ahead of consensus of $1.14.  The company beat on both metrics keeping investors and investment bankers happy for another quarter.  Several analysts revised upward Cash Flow per Share (CFPS) to recognize improved company performance.

The company seems to be a well run company, executing in a industry that seems to be struggling with commodity pricing, output cost inflation and decreased industry equity valuations.

One does have a sense, like any other growth stock, if CPG were to disappoint in the above noted metrics, oil production and cash flow, investors will be annoyed with possible consequences for CPG’s stock price.

Cash Flow versus Earnings

This is where the rubber hits the road for investors.  Crescent Point, as I stated earlier, is paying out an annual $2.76 a share in distributions on a monthly basis.  This payout offers investors a yield of 7.3% based on CPG current stock price.  This yield is “juicy” and certainly higher then anything else of quality in the fixed income area.

Highlighting my table (see above) the company seemingly does have the cash flow to pay such a generous distribution to its’ shareholders.  However earnings of the company over the last few years have been meager to say the least.  So which row of numbers, cash flow/share or net income/share, is more relevant to you the investor?

We use earnings per share in the calculation of model price.  Why?  Here is the distinction.

Ask yourself why the accounting profession, which I belong, has spent the last hundred years trying to define earnings of a company.  The reason for this pickiness is the earnings of a company belong to the common shareholders after all actual and potential stakeholders are accounted for.  An accumulation of these earnings is held in the retained earnings of the company.  The company builds equity, if you will, over time through compounding belonging to the owners of the company – the shareholders.

Cash Flow belongs to the enterprise.  Various stakeholders, debt holders, pension liabilities, banks, suppliers, employees all have claims against the cash flow of the company.  A company must continually invest in plant and equipment, people, R&D to maintain their competitive position.  Various managements, over time in the annals of financial history, can and have, restricted expenditures, boosting cash flow substantially in the short term only to the determent of the company longer term.  (I am NOT saying this is the case with CPG) In other words cash flow can be manipulated, volatile and of little use to the common shareholder as information regarding the financial net worth of their company.  Don’t get me wrong, cash flow is important to the company.  Without positive and sustainable cash flow the viability of the company can be impacted.  I am not arguing otherwise.  The issue becomes what number, cash flow or earnings, is more credible for valuation purposes – we favor net earnings of the company.

Lastly I found this quote from Graham and Dodd!

“No one questions the importance of cash flow– it is required to service debt and finance future growth, and it is the best predictor of the future stream of dividends.  However, we reject the notion that cash flows should be thought of as being the same as earnings.”  From Graham and Dodd’s Security Analysis – Fifth Edition. Page 262.

Model Price is falling for CPG

CPG maybe meeting and exceeding expectations with regards to production and cash flow however actual net income along with other metrics we use in our model price algorithm has been less impressed yielding a downward sloping model price calculation over the last 5 years.

Looking at the published financial statements of Crescent Point Energy (CPG), December 31, 2012, we can review the retained earnings to see how much has been accumulated on behalf of shareholders.  The retained earnings balance has a deficit of $2.755 billion dollars.  In other words the company has paid common shareholders $2.755 billion more than what they are entitled to.  So there is an overdraft, if you will.  Who is covering this overdraft?  Strangely enough, the common shareholders themselves are covering this overdraft with dilution of their own shares.

Huh?

OK, the accountants – yes the guys and gals with the green eyeshades – have determined that common shareholders have been paid too much by way of distributions relative to accumulated of Net Income – retained earnings – of the company since inception.  So who made up or funded this $2.755 billion difference?  The common shareholders with additional shares issued!    As additional shares are issued the less fractional share of the company you own.  From the beginning of 2010 – assuming you purchased shares on this date – your share or ownership stake in CPG would have been diluted by some 45%.

So What?

“So what?” you say, and continue;  “My CPG shares are trading in the stock market at the same value that I purchased them back in January 2010 and I’ve been receiving my distribution to boot.  Certainly this makes CPG is one of the best performers investment wise considering both equity and fixed income alternatives.”

To which I say; “Yes, you are right!  However …”

One has to ask, “Without major corporate finance activity in the last two years would CPG have been able to pay their distributions?”

“What if CPG is too generous with the company’s distribution (yield), which is directly responsible for the elevated valuation of CPG’s current stock price?”

“What if CPG is relying on secondary share offerings to fund the company’s current high distributions instead of relying on its’ own business operations?”

“What if capital markets, which can be fickle, are not as generous to CPG in the future as they have in the past?”  The last secondary issue for CPG was back on November 1, 2012 the company issued 18.75 million shares at $40 per share.  With investors down 6 percent, will they readily accept more shares even though they have been collecting their distribution?

The second consideration is the law of large numbers.  With a market capitalization of $14.8 billion and distributions of over $1 billion dollars annually to shareholders Crescent Point is no longer a small-capitalized company.  As companies get larger, laws of compounding and acquisition size become problematic, as the numbers just get unrealistically large for the company to manage or to meet shareholder expectations.

I’m just saying there are limits both in terms of investor’s appetite for additional CPG shares and compounding law of large numbers.  Today there are “clear blue skies” and no sign of investor fatigue of corporate activity but in the future who knows.  I do have to ask the question with corporate activity possibly diminished can CPG sustain its distribution policy to its shareholders.  Leading to the ultimate question of this blog, without the generous distributions of CPG are investors and market participants more willing to see the clear divergence gap opening up between our model price calculation and the CPG’s share price.  Who knows!

Conclusion

So there you have it.  This will be an interesting situation in seeing how this divergence gap, between our model price calculation and CPG current stock price resolves itself, and I will be in the front row.  With all the corporate activity CPG has been doing over the last few years, both acquisitions and secondary offerings, coupled with large distributions relative to what is available in fixed income, investors can be challenged in deciphering what fair market value would be for Crescent Point Energy in the public markets.  The Model Price Service – our Facebook App – crunches the numbers and calculates model price consistently focusing on the relevant inputs that calculate our model price, including our focus on earnings instead of cash flow.  Pundits and experts may rely on cash flow and yield but unfortunately these attributes are NOT variables that make up fair market value of a public company in my estimation or variables used in our calculations.

I’m on Market Call!

On Wednesday, December 3rd, 2014, I will be on Market Call on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Mark Bunting.

 

Take this opportunity, open our Model Price Facebook application and follow along while I’m on the show answering viewer’s questions about individual stocks.

 

Would you say anything different based on your interpretation of Model Price Theory [MPT] and chart? You can make your comments via Facebook.

 

Should be fun!

Teck Cominco Goes “Into The Blue”!

 

NEWS FLASH – NOVEMBER 10, 2014 CITIGROUP CUTS 2015 IRON ORE PRICE EST. TO $65/TON VS $80/TON, SAYS IRON ORE PRICES MAY FALL BELOW $60/TON.

 

Welcome to the new world of decreasing commodity prices.

The business media still hasn’t got their arms around this story. And it’s a big story.

China added 5.9 billion square meters of commercial buildings between 2008 and 2012 – the equivalent of more than 50 Manhattans – in just five years and that’s a lot of steel/copper!

What do you think is happening in China now?

Are they going to build another 50 Manhattans…probably not is my guess.

Iron ore prices started around $16 per dry metric ton in 2004 and spiked to almost $200 a ton in October 2010 and now it’s on the way down as you can read from this tweet from Twitter.

This shouldn’t be any surprise to the Model Price user. There have been many negative transits of Teck Cominco since peaking in price in early 2011 and finally falling into the “Blue” – going below EBV-3 – some six weeks ago and one of our strongest sell signals. See Model Price chart below.

Teck Cominco with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Teck Cominco with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

 

Now if Teck Cominco was trading at over $60 per share in early 2011 and is now trading for less than $18 today, one would think that most of the pain would be over for shareholders. And you can probably see the value orientated money managers rubbing their hands in glee. Teck now trades at about 45% of accounting book value and pays a generous 5% dividend yield.

As a matter of fact while enroute to the office kitchen last week, I overheard on the trading room television – which is always tuned into BNN – a portfolio manager recommending Teck Cominco to viewers with the usual comments…. “Great management, great assets and of course, a nice dividend”!

Really!

What Model Price Theory [MPT] is saying?

When the stock price of a public company drops below EBV-3 this signifies that balance sheet write-offs of recorded asset values will be coming sometime in the future. And when the company starts to write-off recorded assets, debtholders start to get nervous. And, you guessed it, when debtholders get nervous the dividend payout to the common shareholders will be cut if not eliminated.

In essence Teck Cominco can and probably will be a ‘value trap’ in that, yes, the company looks like it has good value, a high discount to accounting book value, and a high dividend only to potentially disappear before your very eyes.

And, yes I have noticed that our model price is calculated at $26 this year and over $40 in 2015. But this is based on equity analysts’ earnings estimates today. Will these estimates be impacted by Citigroup’s lowered forecast estimates for Iron Ore? Has the declining spot price of Iron Ore fully reflected in the estimates we are currently using? And has the declining price of Iron Ore been so precipitous that equity analysts have been frozen and have not updated Teck’s earnings waiting for some sort of stabilization in the pricing of the commodity so any earnings estimate – guesstimate – can be realistic.

Of the two pieces of information – model price value or EBV Lines – my preference is always tilted towards our EBV Lines especially in down markets. Why? It’s what the market is communicating that has more value to Model Price users than what the analysts are saying.

Most Cyclical Stocks Are Pro-Cyclical

What do I mean by this….pro-cyclical? Cyclical companies balance sheets also seem to explode in the dollar amount of net equity or net worth as a consequence of peak cyclical earnings and intra-industry acquisitions. Have a look at our long-term model price chart of Teck Cominco’s. Notice how the balance sheet of the company has grown since 2004 – upward sloping EBV Lines mirroring the growth of Teck’s balance sheet (below). Hmm…. Can this balance sheet growth be a coincidence with the price of Iron Ore? This is what I mean by pro-cyclical in that, in this case, as the price of the commodity – Iron Ore – escalates so does the balance sheet of the company.

Teck Cominco's Long-term Model Price chart from 1995 to Present

Teck Cominco’s Long-term Model Price chart from 1995 to Present

As commodity prices recede or reset, to much lower prices, the company is forced to write-off excess assets that are non-productive or non-economic relative to the cost of production versus the falling price of the commodity in question.

As the write-offs occur over a period of time or the ‘big bath’ write-off is taken – usually by new management not accountable for past investment decisions – the size of the pro-cyclical company’s balance sheet reverts back to lows seen at the bottom of previous cyclical lows. And cyclical lows for Teck’s balance sheet is a long way down as you can see.

Conclusion

So don’t be fooled. Yes, Teck Cominco seems cheap. Yes, the company is paying out a healthy dividend. And, yes, our model price calculation is above where Teck’s currently trading at what appears to be a 43% upside. But our model price calculation is only as good as the group of analysts with their earnings estimates and nobody I know has a crystal ball or better still knows what is going on in China.

The very important “tell” here is the share price of Teck going below our EBV-3 or as we say in our office ‘Going into the Blue’. This is very important information alerting investors that serious balance sheet realignment (write-offs) will be coming.

Yes, you can see the future in this situation and the counter-cyclical forces will play havoc on investors who think they are purchasing Teck’s recorded assets at 55 cents on the dollar and a dividend stream – yes, getting paid to wait (cough!) – that may not last beyond a few quarters!

 

 

 

 

 

 

 

 

 

 

 

 

November 2014, S&P/TSX Composite Market Strategy Update

My friends this Canadian Index is far more interesting to talk about!

The last month and a half has been brutal to all commodities especially gold. As I have noted in previous blogs the sub-index sectors of Energy and Materials (which includes gold stocks) represents 36% of the Canadian Composite Index weightings compared to 13% of the S&P 500 Index. With such a large weighting in commodities obviously the S&P/TSX Composite Index has been adversely impacted.

Model Price Chart of the S&P/TSX Composite Index

 

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines).

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines).

 

The first very apparent observation you can make of the above model price chart is the negative transit of EBV+2 in the middle of October – annotated by the arrow.

This is significant.

Negative transits, as I have written about many times, indicates a change in fundamentals. Unfortunately, as longtime followers of Model Price Theory [MPT] know, negative transits usually corresponds to negative future economic fundamentals.

I have said numerous times Model Price Theory [MPT] is NOT ‘Technical Analysis’ in the traditional sense however because we extensively use price graphs to display mathematical fundamentals repeatable ‘graphical formations’ are inevitable.

Keen observers will note that this Composite Index closed above our EBV+2 line on the same week as the negative transit. Unfortunately this is a normal repeatable ‘graphical formation’ of negative transits and I’m speaking with 15 years of experience here.

The first negative transit is usually the market testing or whether the index belongs in a lower zone, in this case between EBV+1 and EBV+2. Again, in general, the market (I’m talking about indices here) usually rallies above the EBV Line it just negatively transited.

And sometime later – could be weeks/months/quarters another negative transit will occur confirming the initial negative transit.

THIS SECOND NEGATIVE TRANSIT WOULD CONFIRM THAT THE CANADIAN MARKET HAS ENTERED INTO A BEAR MARKET.

Do I have your attention!

Does this mean the world comes to an end? Of course not! It’s just that an investor/trader has to adjust their expectations. My most profitable trading has occurred in BEAR markets of the past. You just have to know what kind of market you are in (Bull market vs. Bear) when trades are initiated and rates of return are assessed.

CONCLUSION

The last couple of months in the Canadian market have been interesting and eventful from a Model Price Theory [MPT] prospective. The highly cyclical market weight portion of the S&P/TSX Composite has been “taken out to the woodshed and shot.” Because of the negative transit of EBV+2 in the middle of October, market participants in Canadian equities should be on guard for a second negative transit that would be a negative sign and possible signaling of negative markets in the future. (As of this writing if the S&P/TSX Composite Index fell below an index level of 14,329 a second negative transit would have resulted.) Can you make money in BEAR markets…absolutely. Model Price will lead the way!

November 2014, Monthly S&P 500 Market Strategy Update

Looking at what the US market did for the month of October, I reminded of what I would call a “Crazy Ivan”.

Yes, this is reference to the infamous movie, “The Hunt For Red October” where we were introduced to Russian submarine captains making aggressive maneuvers, turns, on a random basis to see if a US submarine was shadowing the aforementioned Russian sub.

Have a look at our model price chart below and see if you don’t agree.

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

 

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2199) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1759) investors would be suffering losses of almost 13%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

IS THERE ANY MEANING TO OCTOBER’S MARKET ACTION?

As I have said previously, any and all index moves within ‘the zone’ – between EBV Levels – is without consequence. What we try to do is measure risk levels intra-zone. In other words when the index level or stock price recedes to the lower EBV Line then investors are taking lower risk than if the index level or stock price closes in at the top or upper EBV Line. This should make some sense.

Transits are another matter. Any transit, index level or stock price piercing an EBV Level, is giving model price users information that the fundamentals are changing depending on the transit. If there is a positive transit, the index level or stock price increases through the upper EBV level, this signifies a positive change in fundamentals is occurring. The opposite is true if negative transits occur.

So as you can see from the above model price chart the US market as represented by the S&P 500 Index sold off in the first two and a half weeks of October, only to rebound to new highs in the second half of the month. This ‘high jinx’ in market action was certainly noteworthy however since all this action took place intra-zone no fundamental economic conclusions can be interpreted via Model Price Theory [MPT].

CONCLUSION

The market was certainly more volatile in the month of October than we have seen in awhile. However according to Model Price Theory [MPT] this volatility is par for the course because all the market action took place intra-zone – between EBV+3 and EBV+4.

Until evidence to the contrary, a negative transit of EBV+3, the bull market in US equities is still intact. So the US market did a “Crazy Ivan”, making some investors nervous and of course giving the permabears something to talk about in the financial press. But fundamentally and according to Model Price nothing has changed by October’s market action.

I’m on Market Call!

On Tuesday, October 14th, 2014, I will be on Market Call on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Mark Bunting.

 

Take this opportunity, open our Model Price Facebook application and follow along while I’m on the show answering viewer’s questions about individual stocks.

 

Would you say anything different based on your interpretation of Model Price Theory and chart? You can make your comments via Facebook.

 

Should be fun!

‘King’ U.S. Dollar Returning!

If you listen carefully the groundwater beneath the global financial markets is beginning to shift. And you should be paying attention.

I’m talking about the U.S. dollar. After more than a decade in the doldrums global financial flows are beginning to find its’ way into the greenback and the financial press have noticed this in the last few weeks.

I believe these global funds flow into the U.S. dollar is a secular (long-term) decade long financial phenomena that will have large impacts on investors’ rates of return for years to come.

And most equity investors have no idea that currency trends have big impacts on potential future gains/losses. Hell, do you know what the academic community says about shifting currency trends. Ignore it! They repeat this mantra like a skipping vinyl record, if anybody knows what this means anymore, that currency movements over the long-term have no impact on equity investment returns.

Really!

I especially focus on the U.S. – Canadian dollar exchange rate – no surprise here – because the majority of our clients at Acker Finley spend Canadian dollars at the end of the day including myself. Getting this exchange rate right is critical to preserving any sort of purchasing power for spending time, whether retirement or vacation time, in the Unites States where the majority of Canadian folks want to spend their leisure time.

I’m also interested in accruing larger rates of return in Canadian dollars from equity asset allocations with little to no added potential risk. And by getting this secular trend correct, the U.S./CDN exchange rate trend, I can easily accomplish this.

Want an example?

To howls of laughter, back in 2001-02, when the Canadian dollar was selling at $0.65 – $0.68 to the U.S. dollar, I predicted the Canadian dollar would eventually be selling at par to the U.S. dollar. I had lunch roundtables at our offices at Acker Finley, made predictions on BNN and made sure all Acker Finley clients didn’t have U.S. dominated assets held in their accounts. (When we started our Acker Finley Select US Value 50 fund in November 2003, we made sure the fund’s assets in U.S. securities were hedged – one of only a handful of foreign mutual funds at the time – so that a rising Canadian dollar wouldn’t reduce the fund’s performance over the long-term. Looking back this decision to hedge our U.S. portfolio materially boosted Canadian dollar returns over the last ten or so years.)

I have changed my opinion on the U.S./CDN exchange rate ….two years ago!

Yes, I have now changed my opinion on the U.S. dollar, actually two years ago, and this decision can be traced to the elimination of the currency hedge we instituted in the aforementioned Acker Finley Select US Value 50 mutual fund. We substantially eliminated all our Canadian dollar forwards on our U.S. portfolio of equities in June of 2012 at $1.0217 cents U.S.

Yes, I bought Canadian dollars at $0.68 cents some ten years ago and sold them at $1.0217 a couple of years ago, not a bad trade! Of course the academic community says ‘in theory’ nobody can do this successfully – trade an undervalued currency for an overvalued one – but to me it’s obvious and I’m doing what I feel my clients are paying me to do even though it may not be obvious to their overall rates of return as purchasing an individual bond or stock!)

Why mention this?

Review all great U.S. ‘Bull’ markets of equities in the past 30 years and they coincided with a bull market in the U.S. dollar. As global funds flow moves into the greenback these now U.S. dollar funds start to look for rates of return. The most convenient risk free instruments are usually U.S. Treasuries but for risk assets the instrument of choice will probably be the S&P 500 Index ETF or ‘Spiders’, as it was in the late 1990’s.

Yes, it’s just that easy. A virtual and prosperous two-step cycle will occur as global funds flow converted into U.S. dollars will positively impact the value of the U.S. dollar against other major currencies (US Dollar Index – see below). Followed by the second step of an allocation of U.S. dollar holdings by foreigners to large capitalized equities having past positive rates of return. Which begets more global funds flow.

Am I guessing here?

No, as with my Canadian dollar call back in 2002, I’m using Model Price Theory [MPT] as the basis for my call. All national governments have balance sheets like public companies that form a basis for our model price calculations that you see in our Facebook application. Back in 1995 the Canadian federal government set us on a road of improved balance sheet solvency by cutting back on federal spending and deficits. The model price math was obvious and my call on the Canadian dollar was equally as obvious by-product of the math. The exciting part is the U.S. federal government’s balance sheet is starting to look at lot better than two years ago (deficits are coming down) and the model price math is pointing to increased solvency, much in the same way as Canada’s federal balance sheet back a decade ago.

U.S. Dollar Index

Here is a chart of the U.S. Dollar Index reproduced from the Wall Street Journal.

Notice this chart goes all the way back to 1997 and shows a weak U.S. dollar relative to a basket of currencies that make up this index.

Source: Wall Street Journal

Source: Wall Street Journal

I know I keep on repeating this often but I’m no Technical Analyst (TA) however I like what I see here. I do like to look for market bottoms especially bottoms that occur over long periods of time and I do believe this U.S. Dollar Index qualifies.

Yes, we are finally witnessing the U.S. dollar is starting to gain in strength after a decade of being the red headed stepchild compared to most of the world’s currencies. Just a couple of years ago financial experts were predicting the end of the U.S. dollar’s world reserve currency status when we, Acker Finley, was buying U.S. dollars on any sign of weakness.

If this U.S. Dollar Index breaks above 90, as illustrated, I believe a long-term rally will be confirmed to all trend followers and momentum investors alike driving U.S. dollar demand to US Dollar Index levels that we haven’t witnessed in over two decades (1982 to 1986 period).

I’m on Market Call!

On Wednesday, September 17th, 2014, I will be on the show ‘Market Call’ on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Mark Bunting.

 

Take this opportunity, open our Model Price Facebook application and follow along while I’m on the show answering viewer’s questions about individual stocks.

 

Would you say anything different based on your interpretation of Model Price Theory and chart? You can make your comments via Facebook.

 

Should be fun!

 

modelprice