February 2016 – Monthly S&P 500 Market Strategy Update

 

Well, that was one hell of a January!

Thank goodness it’s over.

Unfortunately the issues that caused the volatility are far from over.

The world financial markets are worried about two big macro issues here, in my opinion. The first being the artificial peg the renembi (RMB) – China’s currency – has with the US dollar. And the second being actions or should I say future actions of the US Federal Reserve. As we all know the Fed has increased interest rates in December along with preparing the market with rhetoric about further increases in 2016: What in heavens name do they do now with the world economy and the US economy clearly slowing down from the albeit low growth levels of 2015?

Until we have answers to these questions… that will reveal themselves over time, obviously… the US equity markets and global markets will be under stress, in my opinion.

Let’s deal with these two issues.

Renembi (RMB) Currency Peg

As I have said in my January market comments (here), China’s economy has clearly and currently slowing down. And at the same time the government wants to transform its economy from a high investment spending/growth economy to one where the consumer leads future economic growth. Again as I said previously, China is doing this transition with large amounts of foreign reserves and the best economic brainpower on the planet. That being said China’s central bank, the PBOC, is literally spending billions on a monthly basis to maintain their RMB currency peg to the US dollar. For example, in December authorities estimate that the PBOC spent $120-$150 billion US dollars buying/purchasing RMB to help maintain the value of RMB against the US dollar. The result? The RMB still depreciated by over 2% against the US dollar in the month of December!

We are waiting for the PBOC numbers but leading experts estimate that the Chinese central bank was more aggressive buying RMB in January than in December. [News Flash – Goldman just estimated that the PBOC spent $197 billion US dollars for the month of January.]

As we all know money is not infinite and experts (and markets) are wondering whether how long the PBOC can keep this up.

The other observation I will make is on this topic is the S&P 500 was down heavily in the first two thirds of the month of January and reversed course and rallied hard for the final third of the month.

Why did the S&P 500, and other global markets rally so hard, at the same time you maybe asking?

I believe little noticed in the business press was a rare interview with Premier Li in Davos, Switzerland – I saw his quote on Twitter and not in the leading business papers. (Premier Li, for those who don’t know is the number two guy in the Politburo and is responsible for China’s economy.)

Mr. Li simply stated that China will not devalue the RMB and the equity rally was on!

But the S&P 500 Index was still down over 5 percent for the month of January.

The world’s leading hedge fund managers are lining up and shorting the RMB believing China will inevitably devalue the RMB against the US dollar. This push/pull will last certainly for 2016 and beyond.

For what’s it worth, I believe China will not devalue its currency. If China wants to become the global superpower of the next 50 years, displacing the United States, the RMB needs to be viewed as safe for international transactions and a store of value for global savings. In lieu of devaluation, China must work hard at internal reforms so transformational that economic change can occur in their domestic economy spurring economic growth and ultimately supporting the value of the RMB.

US Federal Reserve

What will they do?

Will the December interest rate increase, be the only rate increase this business cycle? What happens if the US economy slows markedly in the coming months? Would they reverse course and lower interest rates they just increased? Would they reinitiate Quantitative Easing [QE4]? And what would be the impact of the Fed’s credibility if future policy decisions were to reverse course and additional non-traditional monetary experiments were put in action.

What if we just hit an unexplained soft patch in the US economy in the fourth quarter and the US economy re-accelerates economic growth for the balance of 2016? And the Fed stays the course and continues with hiking interest rates and draining excess bank reserves. Certainly this policy response would result in the US dollar gaining strength in the foreign exchange markets, further increasing the pressure on the PBOC trying to maintain the currency peg I was describing previously.

Model Price Chart

Let’s have a look at our current Model Price chart for the month of January, leading into the month of February 2016 of the S&P 500 Index.

sp500.n236

S&P 500 Index Model Price Chart with EBV Levels and Weekly Price Bars

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 equity market, as defined by the S&P 500 closed February 1st at 1939.38. If the market rallied to EBV+4 (2199) this would represent a gain of some 13%. If the market corrected back to EBV+3 (1766) investors would be suffering Index losses of almost 9%.

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

Conclusion

I believe the most amazing thing about the US equity market is we are not at EBV+3, yes some 9% lower! The market is throwing some big macro issues at all financial markets and the S&P 500 index seems to be the most resilient of any global equity market. Yes, stocks in the S&P 500 index have been getting crushed and are in their own BEAR market. However others, admittedly few, are reaching new all-time highs keeping the index value above our calculated EBV level.

Obviously this could change at anytime. And, if or when, the S&P 500 were to fall to EBV+3 the market could crawl along this EBV level for quite sometime.

But, in my opinion, global macro issues are in control here and we need some clarity certainly on the two issues raised above before equity valuations go substantially higher.

As always we’ll see what happens.

I’m On Market Call

On Thursday, February 4th, 2016, I will be on Market Call on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Andy Bell.

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!

modelprice

January 2016 – S&P/TSX Composite Market Strategy Update

The selling continues.

But you should know this.

Model Price Theory [MPT] has been very good; scratch that, excellent, in telling you what was going to happen. (And what will happen!)

Backing up we saw a negative transit of the S&P/TSX Composite of EBV+2 back in June of 2015. This negative transit was a sell signal for those not familiar with our Model Price work. Subsequent to this negative transit, the Canadian index went to the bottom of our EBV zone (between EBV+2 and EBV+1) in late August. Since August we have been bouncing along EBV+1 ending 2015 with two negative transits (yes, another sell signal) of EBV +1, one in the middle of December and the other, believe it or not, on the last day of the trading year (December 31), giving Model Price users a heads up on what the opening of 2016 would look like – down about 8% in the first week and a half.

Here is our Model Price chart

sptsx.to212

S&P/TSX Composite Index with weekly price bars and EBV Lines

I have been negative on Canada since the negative transit of EBV+2 back in June 2015. And I have expressed so in my comments on Facebook on our Model Price app. We are in a BEAR market and it’s obvious to me we have to go to a place on the Canadian index that represents value. What is that EBV level? Well, our green line or EBV of course.

Is this the first time I’m saying this? Again, of course not. Here is an excerpt from my November 12th, 2015 blog here:

“So the question on my mind is; at what valuation or EBV level should this rebuilding start?

 My answer: At EBV or our calculated green line on our Model Price chart. This level is calculated at 10,566 as of November…

 Yes, that’s a full 22% lower than the S&P/TSX Composite Index close on November 5th, 2015.

 Gulp!”

Here is our long-term Model Price chart for the S&P/TSX Composite Index

sptsx.to211

S&P/TSX Composite Index with monthly price bars and EBV Lines

How do I know we are going to EBV?

Looking back we can see (and I have annotated (above)) where the S&P/TSX Composite Index bottomed out during the financial crisis of 2008-09. Yes, it was at EBV or our green line.

Yes, no rocket science. No MBA or CFA required. An obvious spot where the S&P/TSX Composite is going to go and hopefully stabilize.

So we will wait.

Again, as I stated in my last blog in November, we could get at this valuation level quickly or very slow. Starting off 2016 one has to be thinking the former. But who knows…

Conclusion

The Canadian BEAR market continues. And the selling seems to be building to a crescendo as most BEAR markets do. This should not be a surprise to anyone who have been reading and looking at our Model Price charts.

And if you’re sitting on a bunch of cash (preferably US dollar cash), Canada does represent a buying opportunity at our EBV Level (Green Line). I know for myself, I will be purchasing both Canadian dollars (converting from US dollars) and the Canadian Index at this level. Looking out 3 to 5 years from now…returns on these purchases/decisions will look impressive I’m guessing.

 

January 2016 – Monthly S&P Market Strategy Update


Welcome to 2016!

And what a start it was. All negative of course, as you know.

In the first day of trading in 2016 the Chinese market sold off 7% and their regulators closed the market. And all this occurred before the opening bell on European and North American markets for 2016. China giving its version of Adele’s “Hello It’s Me” to the rest of the world.

And so everyone, globally, hitting the sell button for the rest of the week…save for Friday…giving us a day of rest not knowing what to expect in the following weeks.

Being in the financial business I hate and bored by the hundreds of financial predictions that will occur for the forward-looking calendar year. Back in the old days, when financial news was very hard to come by, predictions from ‘old sages’ (Bob Farrell and the like) seemed to have good value and laced ‘nuggets of gold’ giving myself a good reason to endure ink stained fingers for a day or two. Now I have to hear millennials giving predictions based on regressed data that has as much nutrients as a fast food meal.

The only prediction I can make is that the financials markets will be open this coming year and stuff will happen. And the market will telegraph whether the economic fundamentals will be improving or getting worst. Yes, that’s right. The market will tell you what’s going on…and it communicates through Model Price Theory [MPT] and all we; as users of MPT, have to do is observe. Prediction is easy however it occurs all year round and not just at the end of December/beginning of January.

The other observation I will make is we are entering the 7th year, marked by March 9, 2009 S&P 500 market bottom, of the financial crisis. Central banks, including the US Federal Reserve, have been experimenting with monetary policy trying to get the global economy back on track of pre-financial crisis global aggregate demand. The preferred policy tool of choice has been printing money or quantitative easing (QE). Asset prices have been boosted including equity valuations and real estate. And I have to admit this is a good thing. The business press is filled with what I call the ‘liguidationists’, who would like asset prices to fall to some 1930s level, so a very small minority, could benefit. This policy response would certainly skew income inequality even more than it is today.

As the US Federal Reserve increased interest rates in December, the market seemed to take this policy action in stride. The financial press and the man on the street was focused, of course, on the 25 basis points increase in Fed Funds. What they don’t see, and is critical, is the ‘reverse repro’ financial mechanism that was introduced at the same time. The New York Fed has been testing this financial instrument for the last two years. Not to get too technical but the Fed through this new instrument will start to drawdown the excess reserves sitting on the banks balance sheets. Estimates range from $3.5 to $2.5 trillion of excess reserves the Fed pumped into the banking system during the financial crisis, that the banks, collectively, have been sitting on and the Fed wants to take some of this back. Of course, they will start slowly at first, say $300 billion or so, but the important thing is the Fed is starting this process.

So over the last year or so, the US Federal Reserve has stopped QE and are in the process of withdrawing excess bank reserves. This is healthy and signs of the US economy returning to normal. Yes, good news…but you won’t hear this anywhere else.

So let’s look at our Model Price Chart of the S&P 500 Index.

sp500.n234

S&P 500 Index with weekly price bars and EBV 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 equity market, as defined by the S&P 500 closed Thursday, January 7th at 1943.06. If the market rallied to EBV+4 (2208) this would represent a gain of some 14%. If the market corrected back to EBV+3 (1766) investors would be suffering Index losses of almost 9%.

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

What is our Model Price chart saying?

Simple, we are in the zone between EBV+3 and EBV+4, as we have been for a year and a half, and nothing much as changed. Yes, within the S&P 500 Index itself, stocks are winning and losing, based on their top line and earnings growth estimates. And this has occurred, cyclical and secular rotations, since public markets were invented.

As I have said previously we could trade down to EBV+3 some 9% lower. But would this be the end of the world? Not according to Model Price Theory. It would suggest, if we were to go there, more upside potential than downside and obviously a good reward/risk scenario for investors.

Is there anything in our Model Price chart that is worrisome? Not that I can see. As you can see the S&P 500 fell to 1867 back in the last week of August 2015. And by the end of October we were within 4% of an all time high!

Obviously the world is focused on China right now. For the last thirty years China has been nothing short of a major economic miracle. From a poor fourth world economy to a $60 trillion dollar economic behemoth and will soon rival the US for economic supremacy. Their next stage of economic development is to transition their economy from an investment lead economy to one of a middle class and consumption. In the history of the world this has not happened to any nation without a deep recession/depression. However, China is doing this transition with large amounts of foreign reserves and the best economic brainpower on the planet. As Bank of England head, Mark Carney said to Charlie Rose in an interview several years ago, it’s in everyone’s interest, globally, that this transition happen without economic repercussions for the rest of the world and every central bank is willing to help China with this transition.

The reason I mention this China has a big decision to make in relation to their currency. They have been pegged to the US dollar and have been feasting or reaping the economic benefits as the US dollar has been low compared to other currencies especially the Japanese Yen over the last few decades. However the US dollar has been rallying because, as I have said previously, the US is emerging from the financial crisis and their currency is appreciating against all other currencies worldwide. So what is China to do here? Because of the currency peg the renembi (RMB) is stronger than most of their competitors (i.e., Japan, South Korea and the like) and putting downward economic pressure on their economy.

The Chinese have been trying to devalue their currency slowly and intermittently against the US dollar over the last few months and this is causing everyone concern. Thus your seeing panic selling in the Chinese markets with ripples out to the rest of the world. For if China devalued the RMB, say 30 to 40% against the US dollar, this would send a wave of deflation out to the rest of the world as China’s manufacture goods would be competitively priced compared to other exporting countries.

And what if the US dollar rallies higher from these current levels? As readers will know I’m predicting a large and secular rally for the US dollar against all global currencies over the longer term 5-7 years. If China is having a tough time at these present levels…what happens if the US dollar rallies substantially higher?

So you can see why there is cause for concern by global investors and they are re-pricing asset prices/valuations in case things go badly.

Conclusion

As last Friday’s job numbers have pointed out the US is finally emerging out of the financial crisis that started nearly seven years ago. The problem at this particular time is much of the global economic world is monetarily out of sync and is either losing their economic strength (China and the emerging economies) or have been mired in very slow growth (Europe) over the last several years. These ‘macro’ considerations have taken over the narrative in global financial markets leaving all participants to be cautious and worried.

Hopefully this ‘marco’ narrative changes in the coming weeks as US companies start reporting their 4th quarter financial results with guidance for the rest of 2016.

Yes, the market could fall to EBV+3. And, yes the S&P 500 Index could rally up to EBV+4 and make all-time highs for the S&P Index. Good companies, will show their stuff in the coming weeks and we will see how the market reacts to possible forward fundamentals.

 

TMX Group – Dead Stock Walking (Reblog)

TMX Group has been in the news in the last few days. First NASDAQ, a US-based equity exchange, said it was looking north to Canada for expansion. And second, Aequitias Innovations, a Canadian competitor to the TMX Group filed a complaint against TMX to the Canadian Competition Bureau over data pricing.

The stock has been hit over the last few days as investors focus on the impact of this recent news. However TMX Group has larger issues according to our Model Price Theory (MPT) math. I wrote this blog back in June, 2013 saying at best the stock would go sideways for the foreseeable future and at worse investors would lose some of their capital over the long haul.

It may take time but the Model Price math always works in the end.

Enjoy!

If you haven’t figured it out yet, I love stocks.  Not only do I love stocks but I want to know what makes them tick.  Why do stocks go up and down?  Why “the market” gives stocks valuation and ultimately takes it away?

As I mentioned previously when I was first introduced to the initial mathematical concepts behind what I call Model Price some 20 years ago, I got it right away – especially the concept of Theoretical Earnings (TE).  Simply stated the calculation of TE of any public company yields what one can call benchmark earnings or what the company should be earning, again in theory, given the capital structure of the company and the capital employed in the business.

Once TE is calculated, you can compare the result to the actual earnings (AE) of the company.  If AE is greater – which it usually is – the market gives additional valuation in the public financial markets for this differential between TE and AE.  If a company is dynamically increasing its AE with TE staying the same or marginally increasing over time, equity markets usually signal its approval of this expanding ratio by increasing the valuation of the company.  The antithesis is also true if dynamically TE and AE as a ratio is contacting, the equity market will take away valuation.

This should make sense to a lot of people.  In essence we are comparing a public company to itself in terms of its own benchmark earnings or Theoretical Earnings.  I like to think of individual companies as unique as fingerprints, each being individually different even though they may compete in the same industry.  CEO’s have a large influence over their own TE calculation in the way they manage their business and can have a direct impact on their company’s valuation, again this should make sense.

If you think my line of logic is sensible – on the concept of TE – and wanted to seek out more information on the topic you will be disappointed.  Unfortunately this financial concept (TE) is NOT taught in any business class, MBA or CFA program.  So by reading this blog you‘re ahead of the other financial professionals in terms of equity analysis.  TE analysis is embedded in our calculation of Model Price in case you were wondering.

We – at Acker Finley, including myself, – are constantly scanning our database of some 2,000 companies looking for any aberrations from past histories in terms of our computations on theoretical earnings and other model price concepts.  This screening process is what I consider fun.  It’s about being curious.  It’s about asking the question “why” and not stopping until I get an answer.  It’s about finding potential catalysts that can have a large price impact on an equity security sometime in the future.

TMX Group (X)

While scanning the database this week TMX Group (X) jumped out at me.  Actually I was scanning the 52-week low list and X was on the list.  I thought this was odd so as usual I call up the model price chart on TMX Group and this is what I see.

TMX Group (X) with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

TMX Group (X) with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

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

This model price chart looked weird to me.  TMX was a quality company since its IPO in early 2000: has anything changed?  Also notice where the stock is trading – just over EBV-2.  TMX is a profitable company with good earnings, so why is the company only trading at EBV-2?  Interestingly our model price calculation seems to support the current market price of the company.

So I start to do some digging.  And wouldn’t you know, TMX Group is NOT the TMX Group!

Come again?

The original TMX group was purchased by a consortium of banks and pension funds commonly known as the Maple Group back in July of 2012.  So the old TMX Group that had a good history of earnings and dividend gains no longer exists.  Once the Maple Group purchased the company – old TMX Group – along with Alpha Trading Systems Limited Partnership (Alpha) and The Canadian Depository for Securities Limited (CDS) it renamed itself TMX Group.

Are you with me so far?

So, in essence this is a new company, with new financial statements.  The model price chart illustrated above is correct (prospectively) but any financial history, including the history of our long-term model price chart is inaccurate.  Keeping this comparable data may be informative from a historical perspective so I will keep the data and chart as is, but meaningless in terms of a financial data continuity and history.

What is the “Theoretical Earnings” of the new TMX Group (X)?

Here is our calculation of the TE of the new X with the past history of the old TMX Group.

image0016

Again, you are looking at two separate companies here. The history of our model price numbers no longer exists as stated on this chart.  But it’s instructive and teachable analysis so I’m keeping it the way it is.

When our computers calculated a TE of $9.69, I didn’t believe it.  This is massive.  Remember this means this company, the new TMX Group, theoretically should be earning at least this amount in order to have any market valuation at all.   I quickly looked at published mean earnings estimates for the company and discovered estimates $3.16 for 2013 and $4.00 for 2014. This is quite a shock.  So like a good accountant I start digging through the financial statements, double checking the numbers – and they were correct!

This is way TMX Group is hitting new lows.  This new company can’t earn their “Theoretical Earnings” the way the new owners constructed their balance sheet.

I could go into the mathematical minutia of why the TE is so large, but it would make this blog post too long and complicated.  In a nutshell the primary cause for this substantial ‘TE’ number was the acquisition of CDS or The Canadian Depository for Securities Limited for a paltry $167.5 million.  This was a terrible mistake, in my opinion.

Why?

Maple Group’s acquisition of CDS moved CDS’s balance sheet from private quasigovernmental ownership to public ownership.  Unfortunately CDS’s balance sheet is too large relative to the earnings the public company actually receives and will ultimately crush the valuation of the public entity.  In order to restore any sense of valuation to the new TMX Group this CDS subsidiary must be placed back in governmental or regulator hands where it previously existed.  In other words this organization, CDS, cannot exist in the public marketplace for valuation purposes however performs a critical market function of clearing financial transactions in the Canadian financial marketplace.

Conclusion

As my title suggests TMX Group is a “Dead Stock Walking”.  This company will never have earnings come anywhere close to its calculated “Theoretical Earnings” number.  The best shareholders can hope for is lackluster to sideways action on the stock price.  The worst is very dark indeed.  If the stock does suffer, which I think it does, TMX Group will have to undergo a major corporate restructuring which may yield interesting profit potential for sharp-penciled investors down the road.

The other question I have is the confusion over the name of the company.  I am in the industry I didn’t know the material changes of the transactions involving Maple Group and the old TMX Group resulting in the new company called the TMX Group.  Without considerable digging and if I didn’t know any better I just thought TMX Group was the…. TMX Group!

I do feel sorry for the current and future high yield dividend investors making an investment in this company.  As I said previously the old TMX Group was a good equity performer with a solid dividend yield.  On the surface the new TMX Group appears to be the same company.  This has disaster written all over it for investors looking for a quality company with a safe and growing yield.

P.S. During the week a new consortium of financial players in the Canadian market place announced the formation of Aequitias Innovations to compete directly with TMX Group.  This is not good news for TMX Group that may face earnings pressure down the road with a sky high ‘TE” placing further potential pressure on the future stock price.

P.P.S.  One of the investors in the Maple Group is the Canada Pension Plan Investment Board.  Great to see my (and your) retirement dollars potentially going up in smoke on this one!

P.P.P.S. I love counter-intuitive situations in business and flawed common sense thinking.  Everything Maple Group did in this transaction seemed perfectly reasonable.  I’m sure the well-intentioned Board of Maple Group with the best minds in Canadian finance congratulated themselves on a job well done.  Also, I would bet money that there were more MBA’s and CFA’s on this file then any other business transaction performed in Canada in the last decade!  Will be interesting when this situation turns south who is left holding “the bag”.  (Hint…. It’s usually the CEO!)

P.P.P.P.S. The last company I saw in the past that had this relationship, too high of a ‘TE’ relative to ‘AE’ was AOL-Time Warner back in 2000.  Yes, you are correct, that didn’t end well either!

 

I’m on Market Call

On Tuesday, December 8th, 2015, I will be on Market Call on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Andy Bell.

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!

modelprice

Model Price Question #3

Facebook Comment or Question

Could it get any worse for VRX-us / VRX.ca ? The company and Bill Ackman are being charged with insider trading on Valeants failed attempt to take over Allergan Inc. Couldn’t happen to a nicer guy.

From ModelPrice Guy

If it rains…it pours! I wrote about this partnership set up between Ackman and Valeant that profited from the initial takeover bid on Allergan called PS Fund 1. Look at my blog on this here.

Follow up Facebook Comment

Brian simply amazing that you were on this back in April 2014. Well PS investments is about to be P…ss.d on by the Feds. You end your blog by saying “what have you been doing for the lst 6 years” Well having retired from the US, i’ve been playing craps with stocks on both sides of the border. Some great wins and a couple, shall we say less than stellar gambles. Ask in 5 years and I bet I will be saying ” Following MPT it has been win after win after win with only minor casualties. Thanks Brian.

From ModelPrice Guy

Great stuff here John. Yes, when I was researching Valeant/Ackman’s takeover of Allergan I couldn’t believe that Valeant and Ackman’s PS Fund 1 was legal, even though as I mentioned a former SEC enforcer said it was. William “The Butcher” Cutting (aka Bill Ackman) is having a hard time lately…this is what happens when you ‘fly too close to the sun.’

Interesting to me the business press, the lazy buggers that they are, didn’t screem ‘bloody hell’ about this arrangement at the time. I was watching Bill Ackman being interviewed by Charlie Rose some time ago and I almost puked in my office waste-paper basket. It was such a ‘soft ball’ interview, with Charlie’s intention of maintaining a friendship outside the studio than asking any hard questions about anything ‘The Butcher’ was actually doing in the investment world. Disgusting! But that’s the Big Apple…when you’re on top as Ackman clearly was at the time…people don’t look at what makes you successful but the end result…money.

The good news the opposite is also true. With trouble on all fronts, including his investors wanting to abandon his investment funds, I’m sure ‘The Butcher’ is having a hard time finding a lunch partner anywhere in the five boroughs.

mpg-1

Model Price Question #2

Facebook Question or Comment

Poor Irwin Michael the “deep value” guy looks to me like he is slowly throwing in the towel. During the 3rd quarter his funds purchased shares of Home Depot (HD-us). I use to watch what he was doing out of respect now I watch to see how bad the train wreck will become.

From ModelPrice Guy

Value and ‘Deep Value’ stocks as an asset class has been getting killed over the last two or so years. Why? We are living in a world of deflation. As stock prices drop this doesn’t necessarily mean they are cheap. The opposite may also be true…. they may actually carry MORE RISK! In a deflation world, what is prized by the market is growth. And with growth the valuation on the company shares go skyward. Companies that are not growing…or worse contracting continue to go down until they go into the ‘Blue’ or below EBV-3. (Materials and Gold Companies!)

Until the deflationary economic environment changes this investment style will continue to underperform in my estimation. We recognized this many years ago and modified our investment style to recognize this new economic environment. Others have not…and they, along with their investors or clients, have paid the price.

What does this mean longer term…we are all chasing the same stocks at the end of the day and valuations on the limited true growth companies are going ever higher.

Until they don’t…. gulp!

November – S&P/TSX Composite Market Strategy Update

Back in March of this year I warned readers that the Canadian equity market as represented by the S&P/TSX Composite Index would have a hard time staying above EBV+2. If you don’t remember my words maybe you will recognize the visual that I thought best represented what the market was doing.

My ‘Hanging in There’ kitten.

Hanging in there!

Hanging in There!

Well the obvious happened. Slowly at first for the months of June and into July, and finally with a selling crescendo being reached at the end of August; the S&P/TSX Composite traded from EBV+2 to EBV+1.

Here is a look at what occurred in the aforementioned months and where we are now:

S&P/TSX Composite Index with weekly price bars and EBV Lines

S&P/TSX Composite Index with weekly price bars and EBV Lines

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

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

What Now?

Canada can be viewed in two different ways economically or better still a two-legged stool. The first is an energy/commodity superpower, largely represented by the western provinces of the country. The second is manufacturing and processing plants that export goods to the United States, located principally in southern Ontario and Quebec. Over the last 10 plus years, and with economic expansion in China, Canada’s energy/commodity sectors have not only driven economic growth in Canada, especially since the financial crash of 2008-09, but also made the country a darling of the hot-money hedge and sovereign wealth crowd driving the Canadian dollar to par with the world reserve currency – the US dollar.

With the Canadian dollar at or around par for a secular period of time Canada’s manufacturing and processing plant/equipment/infrastructure either was mothballed or worst; permanently destroyed as foreign companies pulled branch plants and relocated them back in the United States or built new facilities in countries such as Mexico.

Well, I don’t need to tell you what has happen to the worldwide commodity cycle in the last 12 months – hint: Commodity prices go down day after day. And that giant sucking sound you hear is all that hot money, that has been so favourable to Canada over the last ten years, leaving Canada in record amounts over relatively short period of time, resulting – not surprisingly – in the Canadian dollar selling off to the $0.77 dollar level relative to the US dollar.

So our exporters should be cheering, right? Unfortunately, little is left to export as worldwide commodity prices hit record lows and our export infrastructure is no where to be found.

Long story short, Canada has to rebuild. And with this in mind Canadians, especially with the help of Ontario and Quebec, have elected a new federal government – from the Conservative Party to Liberals – to spearhead efforts in this direction with new faces and emotional energy.

So the question on my mind is; at what valuation or EBV level should this rebuilding start?

My answer: At EBV or our calculated green line on our Model Price chart. This level is calculated at 10,566 as of November I that have annotated on the chart above.

Yes, that’s a full 22% lower than the S&P/TSX Composite Index close on November 5th, 2015.

Gulp!

Now this can happen two ways, as we all know. Fast and quick (like pulling off a Band-Aid) or slow, first with a negative transit of EBV+1 and then with a downward grinding market – picture in your mind’s eye sandpapering your floor boards by hand – until the Toronto Index settles down at our calculated EBV support level.

So am I super bearish on Canada? No I’m not. We, as a country; and I being a resident of Toronto, am bullish on what Canada has to offer in terms of future growth – albeit slow growth because of unfavourable demographics that I will blog about later – and a good place to live. I am just pointing out the obvious in that Canada or more importantly southern Ontario restructuring or a rebuilding of infrastructure will have to occur. And as I look and drive around the City of Toronto what do I see? Massive infrastructure spending, both above and below ground, helping transform Toronto for the 21st century for the millennial generation.

As the hot money rolls out – if there is still some left – Canada needs to get cheap enough where the smart money can invest in an undervalued currency and assets – assets whether left behind or freshly built new plant and equipment – for the next expansionary cycle sometime down the road.

Conclusion

In my opinion, the Canadian S&P/TSX Composite Index will seek a lower valuation level on our Model Price constructed chart featured above. This will bring this Index down another 20% or so, where I believe equity valuations, in general, will look interesting and cheap relative to global equity markets. The question, of course, will be one of timing and the speed with which said Index goes to this level.

Would I sell everything Canada and head for the hills? No, I would not. The tide, in terms of money flows, has been going out for a while but it’s not over. Selective good investments still do exist and will weather market downdrafts if they occur. Plus, having Canadian dollars invested at our EBV Level will probably look smart sometime down the road when the global money-flow tides start to reverse.

November 2015 – Monthly S&P 500 Market Strategy Update

When I last wrote about the S&P 500 back in August, the index certainly looked like it had a chance it would fall back to support or EBV+3. Circumstances or should I say non-events namely the US Federal Reserve NOT increasing short term interest rates in September has given this index a lift in valuation.

Since the end of September the S&P Index has lifted back to where it has been for much of 2015, hugging just underneath EBV+4.

Have a look.

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 equity market, as defined by the S&P 500 closed Monday, November 2 at 2104.05. If the market rallied to EBV+4 (2214) this would represent a gain of some 5%%. If the market corrected back to EBV+3 (1771) investors would be suffering Index losses of almost 16 %.

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

Back at the Top of the Zone

The market variability or correction in the last week of August and all of September was, of course, another opportunity for ‘buy the dip’ investors to acquire companies at discounted prices. We ourselves were excited to have this market correct back to EBV+3 and predicted in my August blog that if this were to happen a big tradable rally would occur off this level.

The rally obviously occurred without the S&P having to seek out support at EBV+3. Maybe the US Fed should be credited with the increase in valuation by continuing their accommodative monetary policy that some say is inappropriate for the current tight labor markets and other strong economic related data points.

Of course, others are pointing to sluggish, if not weak, economic data not only in the domestic US economy but also internationally as a reason to stay accommodative and not increase interest rates.

Reasonable men and women can either agree/disagree on where the US economy is headed and what the appropriate monetary response should be. Unfortunately, when the debate rages on at the highest floors Federal Reserve Board this can be disconcerting for the market participants and asset prices alike.

From a point of view of day-to-day the market may seem random or nonsensical: But it isn’t. As displayed in our Model Price chart the S&P 500 Index is trading between EBV+3 and EBV+4 is logical and rational to those of us with ‘Left Brains.’

Will the S&P 500 Index have a positive transit of EBV+4 in this economic uncertain environment? Probably not. So EBV+4 becomes resistance and a big barrier for the US market to go higher in terms of valuation.

Will the S&P 500 Index have a negative transit of EBV+3? Again, probably not. The economics aren’t so bad that equity valuations can drop precipitously triggering a negative transit (of EBV+3) indicating deteriorating economic fundamentals in the future.

So we sit and wait.

The Fed in its last meeting in October is talking tough again and threatening to hike short-term interest rates in December.

Jeez Louise!

And with the S&P 500 climbing to the top of the zone and closer to EBV+4, doesn’t this spell trouble if the Fed actually went ahead with its tough talk.

Hmm….