Monthly Archives: June 2012

What other things are in my long-term file?

I have had comments from readers what other things I have been accumulating in my long-term file – with reference to my previous blog.  As I skim through the file two pieces stand out.

U.S. Housing Market

The graph below charts the U.S. Existing Home Sales – Left Hand Scale with the U.S. Housing Starts – right hand scale.

The U.S. is 4 years into their housing price deflation.  Believe it or not house prices, in general, are up 1.4% year to date, with housing starts trailing household formation by more than 50% for 4 years, with inventories more balanced.  This period was brutal for the American homeowner however I believe we are seeing signs of mean-reversion and the market coming into balance.  Market Strategists like to point out a huge supply of foreclosed homes still on the market, which I will concede, however these homes, which I have seen or been told about are NOT livable in their current state and have to be torn down or renovated.

Also, anecdotally I have a friend who runs a distressed real estate fund trying to buy distressed properties along the Atlantic coast of Florida.  They purchased some pieces for their portfolio but they now have “given up” as prices have escalated and lack of properties have diminished opportunities on the Atlantic side of Florida and are now searching on the Gulf side.

Housing does represent about 8% of the U.S. economy and if this sector at least stabilizes – instead of being negative – this will boost the U.S. economy as a whole.

Equities Yield relative to Fixed Income Yield

The chart below highlights the spread between the U.S. 10 – Year Bonds yields with the S&P 500 Dividend Yield.  For instance the 10 year U.S. Treasury yields 1.61% versus the dividend yield on the S&P 500 at 2.15%, representing a 54 basis point advantage.  This chart goes back to 1956 and as one can see we haven’t seen this spread since the 1950’s or 56 years.

In Canada, the S&P/TSX dividend yield of $3.2% is 137 basis points above the 10-year Canadian bonds, also one of the highest spreads in almost 60 years.

I know these factoids have nothing to do with Model Price, or our Model Price Charts.  But I do look around for long-term secular historical facts that can support what I am seeing in the Model Price world.  In order to have a bull market, we need to start from a point of undervaluation where invest themes come together to support increased valuation to overvaluation.  The puzzle isn’t complete as yet, as I have warned in my previous blog but conditions are slowly moving into place for a bull market in U.S. equities.  For now, my long-term file just keeps on getting fatter!

US Energy Self-sufficiency – Big Game Changer for Investors

Secular (long-term) trends are big friends to investors knowing what to look for.  My last big call was the Canadian dollar back in 2001.  Everything was in place to see the Canadian dollar rise from the 68-cent level versus the US dollar to well over par in 2007.  Even though we held round table discussions with clients and anybody who would listen to us back in 2002, many couldn’t believe the scenario that I presented.

I see the same conditions forming with regards to the US dollar.  There is obviously a few more pieces of the puzzle that have to put in place to make this a strong recommendation on my part, but the evidence is clearly taking shape.  One of the key pieces was on the front page of the Wall Street Journal today.  This article will be clipped by myself, and placed in my long-term file as part of my work on why the US dollar should be bought as a secular investment.

I will try and give you the link however the Wall Street Journal does hide behind a pay wall but the thrust of the article goes like this.

America will halve its reliance on Middle East oil by the end of this decade and could end it completely by 2035 due to declining demand and the rapid growth of new petroleum sources in the Western Hemisphere, energy analysis now anticipate.

By 2020, nearly half of the crude oil America consumes will be produced at home, while 82% will come from this side of the Atlantic, according to the U.S. Energy Information Administration.  By 2035, oil shipments from the Middle East to North America “could almost be nonexistent”, the Organization of Petroleum Exporting Countries recently predicted, partly because more efficient car engines and a growing supply of renewable fuel will help curb demand.

“U.S. oil production was for nearly 40 years in total decline, and that decline was never supposed to end,” says Jim Burkhard, an analyst with HIS CERA.  “This is a major pivot point”

The shift away from Middle Eastern oil means closer ties with Canada, which is emerging as the top U.S. energy ally, but also with Latin neighbors that are strong trading partners.  A dollar spent buying oil from these countries is more likely to end up back in the U.S. than a dollar spent buying Iraqi or Saudi crude.

Since the early 1980’s, more than 30 years, America has had a chronic current account deficit with the rest of the world.  Certainly over half of this accumulated deficit had to do with purchasing Middle Eastern and OPEC oil, which would amount to tens of trillions of U.S. dollars circulating around the globe keeping the U.S. dollar down versus world currencies.  By shifting oil purchases away from Mideast Oil will have a huge impact on the U.S’s current account deficit, thereby helping the U.S. dollar on a secular basis – smaller U.S. current account deficit meaning less outflow of U.S. dollars in the world, therefore making the dollar more valuable.

To me this is a major game changer for investors.  Over half of the pieces of the puzzle are in place for a major bull market in the U.S. dollar and U.S. assets.  Oil self-sufficiency is a big piece of this puzzle.

I know, I know, you think I’m crazy.  Yes, I know, nobody thinks this!  While laying out my case for the Canadian dollar my biggest skeptics were the ones who said, “everyone saw that coming” as the Canadian dollar reached par.

My Six Thoughts and Observations on the Euro

As the Greek election furor dies a quite death and as of today Greece has formed a new government.  I have been reflecting on the question, ” Was the fear and panic leading up to the Greek election on June 17, 2012 worth the bother?”

So for what it’s worth here are my thoughts and observations on the euro.

1.  The only people who think the euro will fail are those who reside and work outside the Eurozone. Why?

Each Eurozone currency note has a country code.  An “X” before the serial number denotes a euro from Germany and a “Y” denotes a euro from Greece.  Certainly if the news were as bad as the press believes there would be hording of the “X” bills and spending or refusing of the “Y” bills.  As of last week, there is no sign of this happening in Spain.  (This comes from a first hand account of a good friend currently vacationing in the Costa del Sol region of Spain.  Also the restaurants are packed according to my source.)

2.  Anyone with an Econ 101 university course knows what to do to fix Europe’s financial problems.  Martin Wolf of the Financial Times points out every week what should be done and how to do it.  Unfortunately, all of the answers reside in the political arena.  My favorite line in the movie Godfather III, “finance is a gun, politics is knowing when to pull the trigger.”  It could be years, maybe decades before any government pulls any trigger.

3.  All of the European banks are bankrupt!  Since 2008, all of the banks in the Dow Jones Euro Stoxx 50 have been trading under EBV-3, or what we call deep “in the blue”.  Unlike, the United States and the United Kingdom who has rescued their financial institutions and is in the process of cleaning them up, Europe has yet to act.  Certainly any road to recovery for Europe must start with the clean up of their banking system.  Which for one reason or another Europe is loath to do.  Over time the interconnectedness of the European financial enterprises will disconnect from the global financial system.  The market will demand this.  In 2008, a bank was only as strong as its counterparty.  The market will not tolerate a weak European counterparty in the global financial marketplace.

4.  Europe’s underground economy must be huge.  This is the only conclusion one can draw.  The financial headlines and the facts on the ground just don’t match up.  To me this is a generational phenomenon and will probably take generations to change this mindset.

5.  Germany likes this situation.  The Euro has been moving lower against the US dollar/Renminbi currency peg.  This helps Germany’s export machine and the current account surpluses continue to pile up.  When “what ever” crises’ reaches a boiling point Germany moves slightly.  By placing a Band-Aid on the wound or throw a few Euro notes at the problem to alleviate the tension.  Secondly, Germany has hegemon over the whole Eurozone.  Germany may have lost the first two world wars in the 20th century, however they won the economic war of Europe in the 21st.

6.  One of the major advantages of a currency block is labor mobility.  The US has the most mobile labor force in the world.  If the Northeast is in recession, individuals pack up and move to the Southwest.  Will this be true for Europe?  Employment should realign itself internally. Young people hopefully will gravitate where the financial opportunities are the most plentiful.  Which will mean out immigration of the PIIGS to the northern part of Europe.  If not, then immigration will occur internationally.   I’ve been hearing of immigration out of Ireland to such places as Saskatchewan where workers are needed for potash, mining and agriculture.  Hard working Northern European workers retiring to the Greek Islands is equivalent to New Yorkers’ retiring to Florida.

Conclusion

I guess this European mess seems obvious to me.  There will be NO grand solution or TARP like bazooka to fix anything.  Think Japan – slow growth with challenging demographics.  Some countries in the Eurozone will thrive others will be zombie like.  Decades if not generations will be needed to fix a continent that was formed to rival the United States.

What is the downside to this?

Not much I believe.  I can point to Japan.  Japan has been sliding for over twenty years economically speaking and world commerce has grown tremendously over this period of time.  The Japanese people don’t seem to mind.  Like I don’t think the majority of Europeans will mind twenty years from now.

What everybody worries about is what has become known as the “Lehman Moment”.  If a European bank fails or Greece pulls out of the Euro, and the credit markets freeze a la 2008.  What if the “Lehman Moment” doesn’t happen after a European shock?  Yes, there would be a substantial rally in all asset classes, except US Treasury bonds and German Bunds and the world will continue on without any regard for Greece and European financial issues that plague us today.  In other words, Europe has been effectively ringed fenced making the world happy as well as Europe.

Let’s Talk About Market Bottoms

Now that the panic and fear is over about the Greek elections and its’ emanate break out of the Euro maybe we can have a logical, rational discussion about the potential bottom for the S&P 500.

I’m NOT saying the equity markets will go to these given levels. However, I think it helpful that these levels are considered for individuals who have money in equities and/or thinking of adding more capital to their positions. I just think it is a matter of interest where previous bottoms have occurred and where are we in relation to said previous bottoms. If fact, we are closer then you think.

S&P 500

Here is the Model Price chart for the S&P 500. Remember, we amalgamate all the model price company graphs in the S&P 500 into one chart, see below, to help us see what is going on in the market as a whole. With today’s positive market action you can see we are potentially on our way back to EBV+3 as I predicted here and here.

S&P 500 Model Price Chart. The S&P 500 closed 1344.78 on June 18, 2012. Economic Book Values (EBV) are the coloured lines.

The S&P 500 closed at 1344.78 on June 18, 2012. As you can observe from the chart, EBV+2 is a significant level for the S&P 500. Looking back at our past data, EBV +2 was the level the market bottomed during the crash of 1987 and the recession bottom and S&L financial crises of 1990. During the 2008 crises the market pierced EBV+2, spiking down almost to EBV+1, before recovering to EBV+2.

More recently, this past correction was the third since the market bottom of March 9, 2009. Each correction may have seemed terrifying but didn’t come close to EBV+2 as in past major market bottoms.

What am I saying?

1. As of June 18, 2012 we are 21% from EBV+2 or a major market bottom going back some 34 years. Yes, I agree going down 21% would not be fun, (and I’m not predicting this) but you would have to agree this would be an important market bottom that could put an end to the 2008 financial crises and mark an important point for recovery.

2. As the market corrects and comes closer to EBV+2, an investor will be taking less risk in the US market than EBV+3. This is hard I realize, but this is where hopefully our model price charts can help average investors. As markets move lower, equity shares have more value for you to benefit in the long run. Hopefully, by pointing out market lows going back decades this will help investors reach for buy tickets instead of sell tickets. See my previous blog on the Rational Investor here.

I’m on Market Call!

On Thursday, June 14, 2012, I will be on Market Call on BNN (Canadian Business Show) 1:30 pm – 2:00 pm (eastern standard).

How Model Price Charts ease my market anxiety?

According to the business news the world is falling off a cliff, financially speaking.  Today it’s Spain, tomorrow Italy and don’t forget that Greek election.  Certainly I do read my share of business press, to make sure I’m current on whatever the non-news seems to be.  I guess it helps to be topical and have the same frame of reference as everybody else in discussing financial highlights of the day.

Then, I start to review our Model Price Charts.  I feel my anxiety level slowly drop to a point that I start to see opportunity in the very stocks the investing public seems to be discarding.  By the end of my review, of about 60 – 70 charts, the world as viewed through the prism of the Model Price Charts, has rationality to it.  To top off my review, I like to go through the 52-week high-low list to get a feel of what is working in the market and what isn’t.  The daily 52 week low list is by far my favorite.  As value managers, I like combing through other investors garbage, to see where investors’ are losing money and maybe spot tomorrow’s winners.

Why do Model Price Charts calm my anxiety?

There is so much opinion and lose facts in the world, it can be extremely hard day by day whether any of it will make you money in the markets or not.  However, there is one thing that is real, concrete and can be relied upon.

Balance Sheets.

Balance sheets of public companies are the most reliable pieces of information an investor can obtain.  There are many reasons why:

1.  A balance sheet has to balance.  Sounds simple enough, however in this upside down world that we find ourselves this is one truism that is comforting.

2.  Economic Book Values are constructed from the balance sheet.  These EBV lines are structural therefore yielding constant values, you and I can trust – obviously assuming the balance sheet isn’t fraudulent.  I realize there are assumptions in all financial statements but the balance sheet, certainly to me provides more fact than fiction.

3.  Economic Book Values as I introduced in point 2 are independent variables, which we outline in a graphical interface or call Model Price charts.  The other independent variable we overlay is weekly and monthly price bars.  This gives users two independent variables interacting together and giving valuable information on what is actually going on not only with individual equity names but also by grouping these names together can give EBV charts on equity indices as well.

Conclusion

In turbulent financial markets I rely more on EBV’s and market prices than any other piece of financial information, including our Model Price calculation.  Keeping in mind that our model price calculation is largely derived from analysts’ estimates, which can be out of whack not only for the individual company in question but also macro considerations such as interest rates and the play by play of what is going on in Europe.

You can lower your anxiety level as well, by learning a few simple concepts, and looking at your favorite equity names on our Facebook database you can place all this incoming bad financial news in some perspective.

Potash Corp. of Saskatchewan – Finally at a price point that makes sense!

There are a lot of stocks on our wish list but the price always seems too high.  As we have stated in our market piece on the S&P/TSX 60 we are at an interesting risk/reward juncture in the Canadian market.  Looking for buy candidates within the index can be a challenge depending on your point of view of the market place.  However scanning the horizon Potash Corp. (POT) does look interesting.

Model Price Chart on Potash Corp. (POT-US)

Potash Corp – US with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

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

Long Term Model Price Chart on Potash Corp. (POT-US)

Potash Corp. -US with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Potash Corp. has bounced off EBV+5 three times since 2008.  Last time POT hit EBV+5 was late 2010, and then traded up to EBV+7.  Well here we are again!

The purpose of this blog is NOT recommending stocks, and I’m not recommending POT to anybody.  However, I do like being a “birddog” if you will and I do like pointing things out.  Potash Corp. is worth pointing out.

S&P/TSX 60 Index – Market Update on the Canadian Market

We have been getting requests from our Canadian readers to do a market update on the Canadian equity markets.  We can do this by looking at the S&P/TSX 60 Index.  Just like our S&P 500 model price chart, we aggregate all 60 companies into one chart, which can give investors a 40,000-foot view of what is transpiring in the Canadian markets as a whole.  I like looking at the S&P/TSX 60 Index because we are large cap managers, and there is enough diversity in terms of the number of companies in this index to get a feel for what is going on.

Here is the model price chart of the S&P/TSX 60 Index as of last nights close.

S&P/TSX 60 Index with weekly price bars, EBV Lines (colored lines).

 

As you can see the Canadian market topped out at EBV+2, concurrent with the S&P 500 index on the US markets.  As the S&P 500 corrected, the Canadian market corrected more severely.  This is not surprising since the current fears are with a slow down in world economic growth, this will directly impact economic sensitive companies which the index has an abundance.

That said Monday’s close of 645, the S&P/TSX index is only 3 percent away from EBV+1 or 626.  So in terms of percent upside/downside, as of last nights computer run, the S&P/TSX index has a possible upside potential of 15.5% and downside of 3%.  Not bad profit/loss potential.  This same situation occurred in the latter half of 2011, which resulted in a rally up to EBV+2.

Since investors and the financial press are extremely pessimistic these days, let’s consider full out disaster.  This occurred in 2008 where the S&P/TSX 60 index traded down to EBV or 513.  That’s 20 percent down from last night close.  Certainly possible but is it probable?  The good news for investors or readers of this blog the index would have to break EBV+1, which would be a very important signal increasing the probability of the S&P/TSX 60 trading at EBV.

Conclusion

What I love about this work, especially our EBV lines, is it’s based on structural equations derived from the balance sheets of public companies.  When we overlay market prices the feedback to investors and analysts’ is immediate.  What is our model price chart on the S&P/TSX 60 index telling investors about the Canadian large cap market?  The current risk reward is positive for the Canadian market, with a 3 percent downside and a 15% upside.

As I had stated in my blog on the S&P 500, if this US index falls to EBV+2, or another 15% then the probability of the S&P/TSX 60 falling to EBV will be high.  However, if this were to transpire I would consider, both US and Canadian indexes, an important market bottom.

S&P 500 – Market Strategy Update (Update 2)

With Friday’s employment number released, and the market reaction to this data point, seems to have everyone running for cover.  Well let’s do a market overview using our S&P model price chart as a focus.  Remember, we have individual charts on every company in the S&P 500 (and many more), so if we aggregate them into one chart, we can perform analysis on the US market as a whole.

We have written twice before on S&P 500 market strategies and here are those blogs.

S&P 500 – Market Talk with Model Price

S&P 500 – Model Price Market Strategy Update.

Current S&P 500 Model Price Chart, based on Friday’s Close

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

As we have stated in our previous posts, above, we thought the market would correct as the S&P 500 Index lifted higher to EBV+3.  I don’t think there is any question we are in correction phase of the market now.  As a reminder, this is what I said on April 11, 2012.

The length and the time of corrections are very hard to predict, even for us.  This correction is beginning when first quarter earnings season is about to begin.  Expect the US markets to be choppy based on which companies are reporting on any given day.  But as we said in our previous post,

 “… the market will correct from EBV+3, which will present investors opportunities to invest in their favorite names.  Yes, we would buy the dips!  Looking for the market to return back to EBV+3.

 Then we should add, the market would probably correct again!  Hopefully, you see the most likely scenario unfolding before your eyes.  As the S&P 500 advances to EBV+3, everyone gets bullish.  Then the market corrects for duration of time and magnitude, the bears win.  Then we rally back to (you guessed it), EBV+3.  Overall the US equity market will move higher, as book value increases. (EBV+3 will increase 18% over the next year.)  However “feel good” traders and market timers, people who only invest when the market “feels” good, will probably suffer losses over the next year.

Current Analysis of the Present Situation

I see no evidence to change the call I made back in the spring.  When you examine our current S&P 500 Model Price chart you see the market has priced in an equal probability in terms of gains or losses.  In other words if there is a public policy response, and the market response is favorable, whatever the policy response is, the market could rally back to EBV+3 or a 15% gain.  If the situation deteriorates further, eroding investors’ confidence then EBV+2, 1067 is possible giving investors’ a further 16% loss as at Friday’s close.

Yes, I know you hate this market now.  Yes, you want to sell every stock you have.  However, the market is giving you better odds today of making money, than when you were feeling good and confident when the market was close to EBV+3 or 1422.  See back in April you had 2% upside and 26% downside.

So what is the probability of a 15% gain versus a 16% loss.  I say 60/40.  The “X” factor is obviously Europe, in that everyone agrees the situation is hopeless economically and the only solution is a political one.  We don’t have a model price chart on European politics!

What I do find interesting is the S&P 500 index is only half way through the “zone” – between EBV+3 and EBV+2.  The business news being so negative you would think the index would be closer to support or EBV+2.  Depending on the news headlines going forward, the S&P 500 index may fall to EBV+2 in the future, further putting the probability in your favor for equity profits.  Hopefully, like ourselves, you took advantage of the market top in April, raised cash, and have a buy list ready for your favorite equity names at cheaper prices.  (Of course using Model Price charts for your entry points!)