Monthly Archives: September 2012

Research In Motion – Still in No Man’s Land

Research in Motion reported earnings (losses) after the close last night, September 27, 2012.  Because losses were less than estimates RIMM rallied after hours more than 20% from its 4 o’clock close.  RIMM also released their financial statements, which we imputed before our nightly computer run, to give us the model price chart below.

Research In Motion with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

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

The important calculation to us is the EBV-3 line.  With the new balance sheet RIMM released, this level is $11.01.  Until the equity price of RIMM crosses this EBV level, there is no real information to act on in terms of trading or investing.  If and hopefully when RIMM crosses this threshold this will signal something more significant in terms of the future viability of the company.

Another important item to observe is the volatility of stock prices when they are trading below EBV-3.  This is “No Man’s Land” in terms fundamentals and stock activity.  With a reported 82 million shares shorted on RIMM, short sellers will get a lesson about trading below EBV-3, especially with option expiry occurring today.  (Got to love gamma week on this one!)

Cage Match – Home Depot (HD) versus Lowe’s Companies (LOW)

(Intermittingly I’m going to write a series of future blogs comparing the internal Model Price math on S&P 500 type companies (Large Cap) for comparison purposes.  Usually this will highlight CEO’s who have done a good job in helping their company achieve a concept, which I define below as “economic velocity” and highlight CEO’s who haven’t performed well according to the numbers.  Along the way of having fun with model price math and what it discloses, I will highlight some philosophical questions incorporating larger economic issues.   I will call this series “Cage Match”)

What makes a “good” CEO?

How does one define a “good” CEO from a “bad” one?  One definition is what I call “economic velocity” of a company.  What is “economic velocity”, you ask? We can guess a company has “economic velocity” by the following attributes.  The company seems to do no wrong.  Earnings are increasing and the stock price is hitting new highs.  I’m sure employees are doing high fives as well.  Business magazines want pictures and interviews.  Television producers are on hold.  I guess if I say Apple Computer, you can picture my concept of “economic velocity” easily.  But the question I have “Is this just lighting in a bottle?”  In other words “Is this just luck, right time, right place for the man (sorry ladies) in the corner office?”  Or is it hard work, special knowledge that CEO’s possess?  Haven’t you always wondered?  I have.  These questions drove me crazy in the past.

Home Depot (HD) versus Lowe’s Companies (LOW)

Let’s compare two companies in the same industry.  Home Depot has been on fire, stock appreciation wise, returning 76% over the last year – textbook “economic velocity” if you will.  Lowe’s seems to be stuck in the mud.  Why does the market like HD over LOW’s?  Let’s have a look at the model price math to figure out what is going on here. First, let’s have a look at the long-term model price charts of each company.

Home Depot with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Note the EBV lines of Home Depot.  Remember EBV lines reflect the growth in net worth of the balance sheet.  See the decline in the lines in 2008, and the relative flatness since then.  This indicates the non-growth of theoretical earnings (TE) (see my discussion of TE below), even though the company was making net income.  As you can see our calculation of model price confirms the move in HD’s stock price.  Also theoretical earnings (TE) are used in our model price calculation.

Lowe’s Companies with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Note the upward sloping EBV lines, compared to Home Depot’s EBV lines.  Simplistically suggesting theoretical earnings (TE) are also trending upward.

As the reader can see back in 2008, both HD and LOW’s were trading roughly at the same valuation – EBV+3.  So let’s have a look at the background data to see what is going on to make an assessment of why Home Depot is doing better then Lowe’s in terms of valuation. In the charts below we can see, that earnings for each company are almost back to cyclical highs, which occurred back in 2007.

Readers will see that in Home Depot’s case the stock’s current valuation has exceeded valuation highs posted in 2007, even though cyclical earnings have yet to surpass 2007 highs.  Interestingly in the case of Lowe’s earnings even though close to cyclical highs however there is little growth in model price and current valuation is just over EBV+3.  Just looking at earnings may lead investors to think LOW’s maybe mispriced?  Or is HD overpriced?

One additional comment, if I may, if Lowe’s had the same valuation as Home Depot, Lowe’s would have an additional market value of some $40 billion dollars.  What is important to note here is the market is not a zero sum game.  In that Lowe’s could increase their market capitalization by $40 billion and not take $40 billion away from anybody else.  Public equity markets are truly wealth creators, if companies – CEO’s – can get their math correct.

Enter Theoretical Earnings (TE)

I talk about Theoretical Earnings under the “Key Concepts” tab of this blog.  We calculate theoretical earnings for every company in our database.  I have included our theoretical earnings on the above graphs highlighting earnings per share of each company.  To make it easier for everybody, including myself, we have made the two data series of each company into a ratio.  Below are the charts on both companies.

You can see the difference between each company.  The CEO of Home Depot is not only increasing earnings but also lowering theoretical earnings at the same time.  What does this mean?  Mr. Blake is increasing earnings with less or decreasing capital from the balance sheet of the company.  From my observation and years of experience using this math the market sends signals in terms of higher valuation from this combination.  However, look at Mr. Niblock at Lowe’s.  Yes, he is increasing earnings as one can see but his theoretical earnings of his company are going up faster then expected earnings gains.  The market, in my estimation, takes a dim view of this.

Knowing, Not Knowing the Math – The $40 billion dollar Question

So assuming the financial world doesn’t have theoretical earnings, my experience tells me that some CEO’s are better equipped then others for their jobs.  The “good” CEO’s are the ones who leach-out capital from their organizations balance sheet both financially and operationally.  Examples of financially reducing their theoretical earnings include share buybacks, paying dividends or extraordinary dividends when excess capital is residing in their companies and an acquisition policy that contributes to earnings more then the increase in the company’s balance sheet thereby increasing theoretical earnings (R+P).  Examples of operational efficiencies include increasing turns in inventories – six sigma stuff, better placement of store locations, and international expansion.

Answering the Question, Who is the “Good” CEO in this Cage Match Situation?

Well I think we both know the answer to this question.  Model Price math is an easy determinate in quickly assessing who is doing the better job, unfortunately the market is already ahead of us in terms of rewarding valuation.  Large cap stocks can be profitable for investors, when a “good” CEO takes over a large underperforming company, performs a turnaround (getting the math right) and everyone seems to be rewarded, the CEO, shareholders, and the economy in general with a higher stock valuation.

However which company is the better investment going forward?

The fun of these Cage Match comparisons is what will happen in the future.  Will Lowe’s shareholders and directors put up with this underperformance for long?  Will Home Depot, and in particular Mr. Blake, continue earning gains with lower TE further expanding valuation of Home Depot or was Mr. Blake just lucky over the past few years?  Which investors will outperform going forward, Growth/momentum investors through holdings in HD or quasi value investors in hopes of a LOW’s turnaround to HD’s valuation?  This will be fun to revisit to see what happens.

Let’s hope Lowe’s can get their math right soon, or Mr. Niblock will be looking for work or giving up some of his titles.  From the proxy statement:

Mr. Robert A. Niblock from 2004 to present – Chairman, Chief Executive Officer, President and Chairman of Executive Committee.

September (Intra Month Special) – S&P 500 Market Strategy Update

Just wanted to give a quick update on the S&P 500. I couldn’t wait another week or so for my monthly update. It’s amazing to see what this market is doing in relation to our Model Price work.

Here is, as of Friday’s close, the model price chart of the S&P 500.

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

Notice what is going on! The market is slowing squeezing up to the EBV+3 line, which is calculated at 1494. Amazing to see, but the real issue is interpreting what this means. Does this market breakout of EBV+3? As I said before, in previous blogs, I don’t think it does – just a guess on my part. Or is the market on the path of least resistance until something happens – news, good or bad – breakout or correction. Also notice these weekly price bars on how the low the volatility is. Or is this just a precursor to larger volatility at a later date?

It is always fun to speculate on the future, especially when it comes to making predictions about financial markets. I don’t know the future, unlike other financial experts, however the S&P 500 has limited upside potential (30 S&P points) and lots of downside. With world central banks in full “Quantitative Easing” mode, it’s hard to conjecture a correction being very deep however as always I would have your list of stocks ready to buy on any dips this market may give us.

Having Fun on Facebook

For those of you who don’t know, I started in September making 4 to 6 comments a day on the Model Price application tool on Facebook about specific stocks.  The stocks I’m commenting on, for one reason or another, caught my attention and worthy of comment.  Completely discretionary in how I pick each stock, by the way.   Have questions about any stocks? Ask away.  Yes, it’s like Market Call 24/7.

FYI, I begin my comments with an equity symbol, with a suffix of either –ca or –us.  This means the appropriate flag one should select before hitting the “Submit” button.

Want to go to Facebook, from this blog, select “Go to Application” button to the right.  If you’re not on Facebook and don’t want to use your real name – no problem.  One of my listed “friends” has a name of “IjoinedfacebookjusttoReadmodelpriceguy”!

“My Grandchildren Won’t see $500 an ounce on Gold”

I was at a small social function on Saturday night, when a lady I didn’t know introduced herself and reminded me of my infamous quote on television.  (For those of you who don’t know I have been on a Canadian cable financial business television channel for the past 13 years.  I appear about once a month giving my opinion on equities and other financial news of the day.) I made this comment – see title of this blog – back in 2003, nearly 10 years ago, and people still remember my call for one reason or another.

Looking at gold today at $1770 US an ounce I obviously blew that call long ago.  Behind this quote I intended a subtle message, which I tried to make about monetary policy.  Since Paul Volcker arrived at the Federal Reserve Board in August of 1979 we have been fighting the war on inflation.  To put this another way, my whole business carrier I have not known a period of time when we, US and Canada, didn’t fight inflation.  When the price of gold topped $800 in the early 1980’s, the price of gold steadily fell as a price signal that holding paper money had greater value than gold or any commodity for that matter.

The pain and the human cost of these Federal Reserve policies of disinflation were high – record unemployment (at the time), transferring low wages jobs overseas, and reducing the power of unions, with decreasing membership. High interest rates and tight money supply where used to ring inflation out of a complex system known as the economy.  This period from 1980’s to mid 2000’s the US economy transformed itself into an economic powerhouse of innovation and efficiency.  This took hard work.  Vigilance from policy makers and politicians kept productivity high and inflation low.  The $500 dollar mark represented to me the point of no return.  If gold traded above this value, all the hard work of the last 25 years would go out the window.  To me this marked the beginning of the end of paper (money) versus stuff (hard assets, commodities).  I didn’t think the Fed would let this happen, and that was the point to my quote.  Gold passed the $500 mark in December 2005, maybe an early warning for the financial crises that was yet to come.

I was feeling melancholy on Friday, the day after the Fed announced Quantitative Easing 3 or QE3.  QE3 will be remembered as the Fed’s “all in” strategy.  The Fed will purchase $40 billion worth of mortgage-backed securities in the private marketplace, and will not stop until policy goals, as set out by the Fed, have been accomplished.  The financial world has become complicated beyond belief, with Fed and ECB (European Central Bank) making macroeconomic policy impossible to extrapolate.  Add on the fact that capital allocation in today’s marketplace can be massively misdirected because of central bank interference prevents one from having a good night sleep.  Investors’ are looking for income or return on their investment dollars “goddam it” and willing to sacrifice their principal – though they don’t know it yet!

Serendipity prevailed on Saturday night with this nice lady’s comment.  Yes, I was wrong in my outlook but it reminded me how far we have come in terms of central bank intervention, the massive devaluation of paper money, and the future impact and implications of financial markets and of society as a whole.

The good news for you the reader, we will see the future unfold within our model price charts. The future financial markets will be interesting, anything can and will happen – then again maybe nothing will happen, for a while – but equity prices transiting through our Economic Book Values (EBVs) will give clues on the future direction of the financial world and equity security prices.

The central banks want inflation.  They will get inflation.  Gold bullion is signaling massive inflation however we don’t now when or where this inflation will show up, but when it does the impact on financial markets will be huge one way or the other.  For instance, the last bond bear market was in 1994, yes believe it or not some 18 years ago!  Once the inflation genie is out of the bottle, another younger version of Paul Volcker will enact policies as we enter a new disinflation period sometime down the economic road.

“The investing public invest on the basis of what occurred over the last 5 years”, an investment great once told me.  I wonder how many of us remember investing in the inflationary times of the late 1970’s and early 1980’s or better still 1994, when there seemed to be no end to bond prices going down.

Yes, there is a lot to think about but at least I have my model price charts, and this helps me sleep at night and dream of $500 gold and my potential grandchildren.

Valeant (VRX) – Rollups, Math and How to become a Multimillionaire!

Last Monday – Labor Day, Valeant Pharmaceuticals International Inc. (VRX) announced that VRX agreed to buy Medicis Pharmaceutical Corp. for $2.6 billion.  The share price of VRX jumped 15%, Tuesday, September 4, 2012 when the markets opened.  This is very rare, that an acquiring company’s stock price gets this share price pop after an acquisition announcement.  Usually shares of an acquiring company fall dramatically after such an announcement.  Ever wonder why?  It’s all in the merger math and the markets seem to know it instantly even though the CEO’s and CFO’s don’t.

I like positive stories, and seeing VRX increase dramatically on this news signaled to me there had to be some sort of story here behind the numbers.  So I took some time to do my research.

Financial markets are about math. The current financial universe focuses on discounted cash flow, enterprise value and valuation tools, which don’t really explain a good acquisition (Good in terms of an acquiring company shares appreciating on a deal announcement) from a bad one, (Bad in terms the acquiring company shares trading down – sometimes dramatically – while the acquired company shareholders get a substantial premium) at least to me.

Have you wondered why the difference?

Remember Harvard MBA’s and CFA’s don’t have model price math.  So let’s see what is going on here and I will explain why Valeant had such a good day, through the math of model price.

Theoretical Earnings (TE)

As a review, our calculation of theoretical earnings represents a specific earnings number that a company needs in order for its’ balance sheet to maintain “state” or stay constant in the future.  Every balance sheet is different, just as a fingerprint, so every calculation of theoretical earnings is unique to the company’s balance sheet.  No finance book I have seen has this concept of TE.  However give this concept some thought and I believe TE makes sense on two levels.  The first level is comparing TE to the current level of earnings.  The company may have some patent or industrial process that produces additional earnings over the company’s benchmark.  We believe the differential between the two, earnings and TE, represents the market value the equity market is giving the company as a whole.  It is the “x” factor in the market value of the company.  We calculate TE on every balance sheet for every company, and keep a database of this number with the financial history of the company.

[Current financial industry practice use rather simplistic ratios like price/earnings, and compare ratios to similar companies in their own industry.  I have never found this particularly relevant compared to theoretical earnings concept.]

The second level is the dynamic between TE and actual earnings per share.  If the spread between TE and actual earnings is increasing the market will reward this company with market value – share price appreciates.  To us this is the most important driver of security prices going forward.  Tell me whether this dynamic is expanding, contracting and I can predict with certainty whether a company’s stock is increasing or decreasing.

So let’s have a look at Valeant and see what the market liked so much.

First let’s look at our long-term chart of Valeant (VRX) since 2005, using monthly price bars.

Valaent Pharma with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

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

Along with the above price chart, let’s review what was going on with theoretical earnings and estimated earnings since 2005.

Let’s also do a ratio chart of the above.

Discussion of the above charts

As observers can see before the selection of the current CEO, J. Michael Pearson, the spread between earnings per share and theoretical earnings was decreasing.  As the ratio was decreasing VRX was losing valuation or market value.  With Mr. Pearson as CEO, one can observe stability between this above noted ratio.  We highlight the merger with a Canadian Pharmaceutical Company  – Biovail – because the balance sheet increased in size dramatically thereby increasing theoretical earnings.  Since the Biovail merger VRX has been acquiring companies, WSJ notes 50 acquisitions since Pearson was rewarded the CEO position, with the above noted ratio of TE and estimated earnings expanding greatly, as one can observe

So let’s take this one step further.  Let’s look at the personality behind Valeant in one CEO named J. Michael Pearson.

Mr. Pearson earned his MBA from the University of Virginia, then went to work for McKinsey & Company.  Having worked at McKinsey for 23 years, rising to Director advising companies in the healthcare field including Valeant. Mr. Pearson left McKinsey for Valeant Pharmaceuticals (VRX) in February 2008.  In other words, he spent his 10,000 hours learning and advising individuals in the healthcare industry and found a vehicle in Valeant to try a business strategy that “went against the grain” of current industry practice, as, noted in publicly available articles.

As reported in the Wall Street Journal, Valeant directors began seeking a new CEO in December 2007. The Chair of the Board, at the time, told Mr. Pearson and two other finalists that he liked the private-equity model for executive pay “because it aligns management’s incentives with those of the investor,” he recalls.  The Directors required the winning candidate to buy at least $3 million in stock, and forgo routine annual equity grants and hold many shares for years before selling.  Mr. Pearson already was advising Valeant as head of the global pharmaceutical practice at McKinsey at the time and had the cash to meet the stock purchase requirement.  He ended up buying $5 million dollars worth of shares at the time.

Skipping to the present according to the latest proxy material Mr. Pearson has beneficial ownership of 5.6 million shares.  Plus with other restricted stock units and performance restricted stock units bring the total shares to 7.6 million shares.  So at the close on September 11, 2012 Mr. Pearson has $430 million in Valeant shares.  Mr. Pearson also will be getting $1,750,000 annual salary in 2012 for his efforts.

Remember this all happened since he joined the company in February 2008.  As we all know not exactly a friendly economic environment to garner this type of wealth.

Great story!

Valeant fits the definition of a “Rollup”

What Mr. Pearson is doing is not unique in finance.  Google the word “rollup”, and you will find in Wikipedia a “rollup” is a technique used by investors where multiple small companies in the same market are acquired and merged by a consolidator (VRX).  No mystery here.  As I mentioned earlier and reported by the Wall Street Journal, Mr. Pearson has overseen 50 transactions since becoming CEO in 2008, expanding the company’s annual revenue from $600 million to around $3.5 billion.  If the Medicis acquisition is completed, Mr. Pearson said, Valeant will have revenue of roughly $4.5 billion.

My takeaways from the above

1.  The model price math, in particular the management of theoretical earnings, from when J. Michael Pearson took over in 2008 to present has been masterful.  The market has recognized this by increasing the valuation for Valeant rewarding shareholders and in particular the CEO.

2.  When VRX announced the acquisition of Medicis Pharmaceutical on Labor Day, VRX jumped 15% because 1) the growth of VRX by acquisition is continuing after the company shares were consolidating over the last quarter or so. 2) Management has demonstrated it can manage TE and more importantly the spread between TE and estimated earnings – in other words I believe the market gave management and market participants the “thumbs up”.

3.  Rollups as a financing technique usually have a lifespan. Either the acquirer (consolidator) runs out of company’s to buy, to fuel future growth or through ego and/or hubris the acquirer’s management acquires companies that are too big thereby substantially increasing theoretical earnings and crushing theoretical earnings versus the forward looking earnings per share spread or ratio. Financial history tells us shareholders at the end of the acquirer’s strategy or a large management “ego buy” bears the ultimate financial losses.

4.  Since Valeant’s management team doesn’t have model price math it is interesting to speculate, at least on my part, is Mr. Pearson doing this instinctively after his 23-year experience at McKinsey or do they some working financial model of their own.

5.  I have spent a lot of time and effort on this blog for a number of reasons.

a) Great real life example of model price cause and the effect on a company’s valuation.

b) There have been thousands of rollups in the history of finance and to me it’s fun to analyze one in action.

c) History tells me I will be writing about this company sometime in the future.  Call this piece a primer for future blog posts.  d) Mr. Pearson went from mere millionaire to multimillionaire status being at the right time and the right company – is he lucky?  Model price math currently says no, however does he know this?

e) Finance is an interesting spectator sport when you know what to look for, hopefully I’m telling you what to look for.

f) Every public company has the ability of managing this ratio, resulting in much higher valuations.  The market pays for efficiency in a company’s use of capital.  Unfortunately in the world of finance today, a Mr. Pearson is rare.

g) As I have stated previously this blog site is about illuminating new financial concepts, which are not in any textbook.  Hope you agree I am doing exactly this.

Blowing Up the Financial Business

I hate the financial business!

There I said it.

I love stocks and figuring out what makes them tick, but the business and regulations surrounding this love affair of mine stinks.

See my blog “Why do stocks go up and down?

Can the internet change this?  Can the internet bring together those of us who love equities and be on the same team? (Do-it yourself investors and the professionals) Helping each other exchange knowledge to our mutual benefit.  People helping people by guiding them on making a few dollars or avoiding catastrophic losses. This is my dream.

The financial business teaches domination.  Ego driven financial domination lead the world to the financial collapse in 2008.  We have so far avoided the Great Depression II with massive deficit spending on part of national governments.  Have we learned anything?  I think so.  National governments let the financial sectors grow to a disproportionate level of their economies, and when their financial sectors collapsed the public found out the dirty little secret that everybody in the financial sector knew – the public taxpayers make everybody whole.  The public is now painfully aware of this dirty little secret and is reining in these once dominant financial institutions.

I don’t know if anybody is noticing but domination of anything is in a bear market.  Ask Gaddafi of Libya or Mubarak of Egypt.  Financial Institutions through Basal III are being reined in.

Looking beyond finance once dominant industries are crumbling or dying a slow death.

My two favorite bloggers are Bob Lefsetz and Jeff Jarvis.  Why?  They were actors in once dominant industries that are slowly dying.  Both are now on the outside blogging what they see wrong in their respective industries.  (Is this my future?)  Bob writes about the music industry, the death of the record labels and how the old business model of the LP (CD) is dead.  Jeff writes about newspapers and how this business model is on life support with no answers in sight.

Usually the change agent usually comes from outside the business.  The internet with news aggregators, instant communication with Twitter and zero cost of digital format can run circles around something physical that lands on your doorstep that has a carbon footprint that should make one blush.  Oh, you like newspapers, that’s fine, do your kids, grandkids?  I think not.

Napster – the file sharing service – killed the music industry.  Do the people in the music industry know it yet?  Bob constantly writes that they, the industry people, do not.  The music industry is still suing their customers for Pete’s sake.

Where is the change agent for the financial industry?  The geeks will have a hard time cracking this industry. A lot have tried and many have failed.  Can somebody inside the financial industry change the financial business?  Hopefully.  I’m going to give it a try.

The internet is about social.  It’s about participation.  Kids and young adults are coming together and sharing experiences.  Sharing knowledge.  Collaborating.  The platforms are interchangeable.  Yesterday, it was MySpace today it’s Facebook, tomorrow it’s _____.  How is the financial industry going to respond to this?  So far the response is to block all registered financial professionals from using Facebook.

How is it that I’m on Facebook, you ask?  Simple and sweet, I’m writing and talking about math, with no security recommendations.   My compliance officer reads everything I post to ensure no industry guidelines lines are crossed.  Unbelievable you say, welcome to the finance business.

Am I witnessing and participating in a dying industry as it is set up?  I hope so.  The finance business needs to be opened up – transparent, for all participants.  Conflicts of interest must be eliminated.  Dissatisfied or wronged customers using financial services now have a load speaker to tell their friends how they have been wronged.  (See Progressive Insurance)

The dominant finance business lives in fear of the internet and social media.  Maybe I’m too early with my vision of “modelpriceguy”, however your kids and grandkids will reform this business and I hope I’m around to see it!

September – Monthly S&P 500 Market Strategy Update

OK, back from vacation.

When I’m away from my model price charts’ for a while – like I was last week, this rarely happens by the way – the upside of the internet, I usually start the process of reviewing individual company charts by looking first at our index charts.  I have reproduced our model price chart for the S&P 500 below.

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

The question I ask myself, where is the index value in the zone?  If the index is at the bottom of the zone the risk reward, index wise, is in your favor.  If the index is at the top of the zone, there is more risk than reward and this should color all the company charts that I review.

Over the last month of August the US market has been what I call “melting up”.  The market seemed to be going up fractionally everyday in August much to the chagrin of the bearish investors and bloggers.  You can also note the size of the weekly price bars and how small they appear.  Investors seem to be taking “baby steps” in pushing the market higher.  Fearful the bottom of the market will fall out anytime a European official or an economic data point increases the odds of a fall recession.

Just as a reminder, this S&P 500 Index chart is an amalgamation of all 500 companies in the S&P 500.  We do not calculate a model price for the index, because the only relevant information to us is where the index value is relative to the EBV levels.  As you can see, EBV+3 (red line) is slightly above where the S&P 500 is currently trading.  This presents investors with the same three scenarios I wrote about on February 24, 2012.

Three Scenarios

Scenario Number One; the S&P 500 could break up and through EBV+3.  This we think would be the most unlikely scenario.  We are still in a very uncertain financial situation with a lot of issues unresolved.  And more specific to our model price work the large US financials, Citi, Bank of America, Goldman, and JP Morgan are what we call “in the blue”.  These massive financials are trading under EBV-3 for those new to our work or at a discount to their reported book values.  To me this sounds alarm bells.  Something is wrong here.  The market is discounting these companies for a reason, which we may never know why?  I find it impossible the market can have a positive transit above EBV+3 without these financials trading above EBV-3.

Scenario Number Two; the S&P 500 goes to EBV+3, and uses EBV+3 as support for sometime until the market gets a green light to break out of EBV+3.  This at best is our most bullish scenario.  From the close on September 4, 2012 (1405) to EBV+3 one year out (1647) this represents a potential gain of almost 18%.

Scenario Number Three; the most bearish case, is that the market falls to EBV+2 or 1077.  Which is 23% from the close on September 4, 2012. The good news is that the projected EBV+2 one year from now, with the growth of the balance sheets, would be 1193 or a fall of 15%.  Better, however still painful.

What is the most likely scenario?

Traffic Light – Yellow (Caution)

In my August 6, 2012 blog I presented readers with my traffic light analogy.  I stated the color of the traffic light would be yellow for caution.  Long story short I would still would suggest a yellow caution light.  As the market rallies up to EBV+3 or 1487 my traffic light would turn red.

Investors and traders are playing with a market, which has limited upside potential (Index wise) and could correct at anytime.  As I have said in previous posts I would definitely buy the dips on the best quality securities as this market corrects.

One other item investors should keep their eye on is Apple.  If there is one stock in this market that is the leader or bell weather it’s Apple.  Here is our model price chart on Apple.

Apple Computer with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

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

Apple represents 5% and is the largest weight in the S&P 500 index weight. Isn’t it cool that both the S&P index and Apple are at the “top of the zone”?  As readers can see the last time Apple traded up to EBV+6, in April, the stock corrected to the middle of May.

This will be an interesting next few months.