I’m on Market Call!

On Friday, May 31, 2013, I will be on Market Call on BNN (Canadian Business Show) 1:30 pm – 2:00 pm (eastern standard)

While I’m on the show answering viewer’s questions about individual stocks, you can input the stock symbol in our Facebook app and follow along – easy.  Just click on “Go to Application” button on the right and this will take you our app.

Would you say something different from what I said?  You can make comments via Facebook.

P&G – As Predicted by ModelPrice Guy time has run out on Mr. McDonald!

When you know model price math you can make predictions and sit back and wait.  Over the last 15 years I usually say to myself, “I saw that!” when one of my notional predictions becomes reality.  One of the objectives of this blog is to write and make predictions with a record, just as I have done mentally in the past, so outside readers interested in finance and valuation can follow along and possibly profit along the way – if they choose.

Back on July 16, 2012 I wrote a blog on Procter & Gamble (PG).  At the time Bill Ackman purchased just over a 1% ownership stake in P&G and intended to shake-up management that he perceived as under-performing.  For fun, I did some number crunching in this blog not only on P&G itself but also comparing P&G with Colgate-Palmolive.

As I have in many past blogs I introduced readers to our key financial concepts like Solvency Curve, Theoretical Earnings (TE) and other financial concepts not taught in any finance class, MBA program nor CFA accreditation.  After doing a review of these numbers and graphically illuminating how these numbers over time foretold the true cause of P&G’s lackluster equity performance.  I concluded this blog with the following conclusion.

Radical change usually happens from the outside.  As you can see from my graphs, especially comparing model price numbers for P&G to Colgate’s, P&G will have to undergo a major cost cutting exercise as well as shrinking their Theoretical Earnings/balance sheet.  Obviously, a company the size of P&G is like watching an oil tanker in the middle of the ocean turn around – in other words this will take time.  Will Ackman/shareholders give McDonald time?  I think not!

Even though I was right on Mr. McDonald the shocking news is P&G’s board brought back Mr. A. G. Lafley out of retirement – P&G’s previous Chairman and CEO.

Huh?

The same A.G. Lafley who spearheaded the Gillette acquisition that I highlight is responsible for crushing our EPS/Theoretical Earnings ratio back in 2006, the main driver for P&G’s lackluster performance.

As I said in my conclusion above, “Radical change usually happens from the outside.”  P&G decided to look inside to cure a problem, lack of equity performance, by bring back the man whose corporate actions contributed or was the root cause of this lack of performance in the first place.

Odd choice.

Links to other Procter & Gamble blogs

Procter & Gamble (PG) – Bill Ackman goes after P&G, What Does ModelPrice Guy see?

Procter & Gamble – Front Page Story in the WSJ turns up the Heat on CEO

Procter & Gamble – Drip, drip!

Citigroup – “Coming Out of the Blue!”

There is so much good news occurring in the United States it is hard for a blogger to catch his breath, especially when you know what to look for.  Well, on Friday we just received another piece of good news confirming yet again the US is healing from the financial collapse of 2008.  We are four months shy of five long years when America’s largest financial institutions not only failed but needed government help in order to survive.  The history of this period, with the many books written and movies produced, is conclusive that without US federal government help Citigroup would have been one of the financial failures along with AIG, Lehman Brothers and countless financial firms during the latter part of 2008.

Citigroup, with assets of over $2 trillion dollars, made this institution one of the “Too Big To Fail” (TBTF) institutions that was ringed fenced by the US government.  If Citi were to have fallen back in 2008, the economic shock would have been so catastrophic and dark economically the world economy would have fallen in a depression that would have rivaled the 1930’s.

Enough of the bad thoughts, as always let’s start with our model price chart.

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

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

As you can see Citigroup had a positive transit of EBV-3 or $50.74.  This is significant because the equity markets are communicating that Citi’s balance sheet has some value.  After almost five years of the equity markets saying the balance sheet of Citi had questionable value, this is a big deal.  I don’t know if many of you have ever read an annual report of a major bank or a “TBTF” financial institution; I would rank these financial reports “the” most difficult to read and or analyze of any publicly listed company.  The reports are riddled with an alphabet soup of financial products and derivatives that make little sense to the layman.  Combined with the fact their stated assets – loans and investments – may have a different market value than the stated asset values recorded on their balance sheets.  It is far easier to let model price theory (EBV lines) and publicly traded equity prices determine whether Citi’s stated balance sheet, including off balance sheet liabilities, have any value.

For fun I thought I would include in this blog our long-term model price chart of Citigroup going back to 2006.

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

Couple of things I would like to point out on this long-term model price chart of Citi.  First off it may shock you that Citigroup was trading over $500 a share back in 2006 and 2007 pre the financial collapse of 2008.  This is a direct comparison to the stock price of today – Citigroup had a very unusual 10 for 1 reverse stock split in March 2011.   So you can see the losses shareholders have suffered over the last six or seven years.

Second, you can observe our EBV lines have what I call a “waterfall effect” from the end of 2007 to mid 2009.  This represents the write offs Citigroup has taken on the stated asset values (and shareholders equity) on the company’s balance sheet.  This is very important because the US government and regulating agencies are very quick to recognize losses on their banking industry’s balance sheets.  This helps the economy recover faster from a financial crises because the free enterprise market and financial intermediation necessary in a complex economic system needs strong and financially solvent banking institutions to interact.  Many countries, including Japan and many of the European countries fail to force their respective banks to recognize bad loans and equity write-downs leaving the banking system in a weaken state as well as their national economies in recession because credit creation is very difficult without strong and vibrant sovereign banks.

Third, Citigroup has tried to emerge from EBV-3 on three separate occasions over the last 5 years (see arrows on the long-term model price chart).  This answers the question “Haven’t investors missed the boat?”  In August of 2011, Citi was trading under $30 and is currently trading over $50.  Citi has been crawling under EBV-3 for almost 5 years and investors in the stock have been taking, in my view, a lot of risk.  Yes, their investment has worked out lately however the risk far out weighted the reward in my view.  With Citi trading under EBV-3 investors could have faced additional balance sheet write-downs, equity dilution through common share issues and or possible nationalization leaving common investors suffering further losses – with nationalization a low probability outcome in the United States but still a consideration nonetheless.  With a positive transit of EBV-3 much of the risk that I have highlighted above has been severally curtailed, mathematically speaking.

This is a Big Event!

I just want to underscore in terms of Citigroup, the company, and the US economy this is a big event.  Solvency was at the heart of the issue in the 2008 financial crises.  Much and maybe all of the US financial industry in the fourth quarter of 2008 was insolvent.  Time, stress tests, unlimited Federal Reserve backing and US government injection of capital – known as TARP – helped keep the financial industry alive through this very dark period in US financial history.  Citigroup faced financial collapse without substantial government aid and implicit reassurances to market participants that Citi was “Too Big to Fail”.

With Citi now emerging and having a positive transit of EBV-3 “the market” is starting to signal confidence in the stated assets of Citigroup’s balance sheet giving further confidence to investors of the ability of the company to stand alone without continual US government support returning Citi to a healthy profitable company pre the 2008 financial crises.

“Coming Out of the Blue!”

For those new to my blog, “Coming out of the Blue” is an investment strategy where investors purchase large capitalized equities as they emerge or have a positive transit of EBV-3.  Since our last EBV line is colored blue, we call this “Coming Out of the Blue”.  This investment strategy is a buy and hold strategy that can take many years to unfold and be profitable.  I have blogged many times of this investment strategy and have blogged on specific names that I will follow up on with additional blogs from time to time.  In this light I believe I will be writing about Citigroup for some years to come.

Again, I do emphasize that I am not specifically recommending Citigroup for you to purchase.  The purpose of this blog is to highlight specific situations that are teachable in relation to our model price work in the hope you can learn our concepts with the potential of passing these concepts unto others.

Links to some of my “Coming Out of the Blue” blogs (but not all).

Questions and Answers about “Coming Out of the Blue!”

How Jumbo Gains are Possible Using Model Price – Part 1

How Jumbo Gains are Possible Using Model Price – Part 2

JP Morgan – “Coming out of the Blue!” (Again)

The Pieces of the Economic Puzzle are coming into Place!

Last week I was spending some time viewing webcasts from the Milken Institute Annual Conference in Los Angeles, as I do every year. (Thank goodness they placed these videos on YouTube.  Is there any reason why anybody would place videos on any other platform other than YouTube?  Please Charlie Rose put your videos on YouTube!).

One highlight was an interview with Robert Rubin, the former US Treasury Secretary and Gary Becker, Nobel Laureate, Professor of Economics and Sociology, University of Chicago.  Both agreed the Federal Reserve Board’s actions in what has become known as QE3 – the third round ‘Quantitative Easing’ – was less effective than QE1.

Really!

Because everywhere I look in the business press, this “fake” US market rally cannot be trusted because of central bank liquidity, euphemistically called QE3, that is driving asset values higher not supported by underlying fundamentals.

The Fundamentals are Improving!

Last July I wrote a blog called, “What is going on with the world of finance, and how do you fix it!” highlighting our Solvency Curve and recommended a policy course of action to change the solvency ratio of various economic actors in the US economy.  I called for substantial tax increases with a reduction of federal spending to increase the solvency of the US federal government.

I stated in this blog,“You mean substantially increase taxes and the economy will boom – absolutely!  You mean substantially cut federal spending and there won’t be a depression – absolutely!  

On Friday, it was reported the CBO now calculates the federal deficit through the first seven months of the current fiscal year that began in October is $231 billion less than the deficit was at this time a year ago.  Also the US Treasury reported on Friday the country recorded a budget surplus of almost $113-billion in April, nearly double the surplus of a year earlier.  Everyone will concede this April budget surplus and narrowing of the US federal budget deficit is because of increased taxes, which took effect on January 1, 2013 along with the budget sequestration – cutting of federal expenses.

There is a link between the US budget deficit and the stock market!  It’s our Solvency Curve.

When I saw this news on Friday about the US federal budget deficit, I thought the US federal government is becoming more solvent.  In other words the US Federal government is “coming up” up the left side of our Solvency Curve.  (See Solvency under Key Concepts).

Here is our Solvency Curve

Solvency Curve

As the US Federal government becomes more solvent and starts to climb the severe curve on the left side of the optimal level of 0.689 (see line), the other participants in the economy will come up on the other side of our Solvency Curve, the right side.

This is how the economy works based on solvency in our view.  This is why the US equity market has been so strong.  The solvency fundamentals for the United States are rapidly improving.  To better visualize what is going on here I have reproduced this chart from the St. Louis Federal Reserve on the US Federal Governments revenues versus expenditures since 1980.

Chart from the St. Louis Federal Reserve Board

As you can see the gap between revenues and expenditures is narrowing.  This narrowing of the gap allows the other actors in the US economy, which are super solvent to feel more comfortable spending some of their savings or cash hoards on products and services thereby lifting growth and employment prospects in the US economy.

Another chart that caught my attention was this chart showing “Household Debt Service Payments as a Percent of Disposable Personal Income”.

Chart from The St. Louis Federal Reserve Board

As you can see because of low interest rates and de leveraging, service payments (interest rates) on debt as a percent of disposable income is the lowest than anytime since 1980’s.  This implies the consumer has potential to add on additional debt again creating economic activity.

It’s the dynamic of all economic actors, in the US economy, becoming more efficient in terms of solvency.  The US federal government becoming more solvent from an insolvent state and everybody else – corporations, individuals, state and local governments, financials – becoming more efficient in terms on solvency by spending their cash on hand or appropriately leveraging balance sheets because of growth opportunities.

In this dance around our solvency curve, the federal government had to make the first move in order for the other participants to feel comfortable initiating action.  The equity markets are sensing this shifting dynamic, again led by the US federal government, and lifting equity levels in the marketplace in anticipation of increased growth and earnings prospects.

The dynamic of these economic actors that shift along our solvency curve is secular (long-term) in nature and can last 5 to 8 years.  So we are in the bottom of the first inning of a virtual circle of US growth and market valuation increases that will be healthy and long lasting just as long as both sides are marching towards balance sheet efficiency at the top of our solvency curve – see above.

Conclusion

It has become fashionable for the business press and the “bears” to pooh-pooh this market rally.  Central bank intervention by way of “QE3” is often sighted as the cause for the market rise with words like manipulation, bubble and my personal favorite “not warranted by fundamentals” thrown in for good measure.  Both Mr. Rubin and Dr. Becker both agree that QE3 is having less impact than the Fed (Federal Reserve) has intended.

The reason, in my opinion, for this US market rally is the link between solvencies of the economic actors in the US economy including the federal government.  There is a real reason why this US equity market is increasing rapidity.  I have started blogging on this subject in of July 2012 (see links below) and have witnessed and participated in this phenomena with excellent investment results in Canada when the same conditions were emerging back in 2002.

Links to my other blogs that I have written on this subject.

What is going on with the world of finance, and how do you fix it!

What is going on with the world of finance, and how do you fix it! (Update 1)

What is going on with the world of finance, and how do you fix it! (Update 2)

Fall Over the Fiscal Cliff, Please!

S&P 500 – Why the US Stock Market is going up! (Part 2)

Cliffs Natural Resources – “Coming Out of the Blue”!

Do you buy stuff “retail” or “wholesale”?

I often equate the investment business to the perfume business.  Everyone wants to pay “retail” for my product. They want what the business press is most excited about.  They want the latest hot IPO or invest in the company with the hottest gadget.  People like “buzz” and energy and seeing their investments in the business news.

They also like simple stories they can focus on.  Gold going to $5000 an ounce is a simple story.  Apple Inc. taking over the world of computing and the Internet is another. And my current favorite the investing public paying “retail” prices for high yielding securities whether debt or equities because of TINA – There is No Alternative.  I hope you know fortunes will be lost on this latest and simplest of financial concepts.

In order to be successful in the financial markets, especially equities, you need to know valuation.  And I’m not talking about price earnings ratios, price to sales, dividend yield and or any other simplistic financial metrics in current use today.  You need a little more sophistication.  You need a new and different type of financial math so you can distinguish “retail” from “wholesale” prices in the equity markets.

So the question is, “How do you know what price you are paying, “retail” or “wholesale”?

One possible investment strategy I have been highlighting since the start of my blog is our “Coming out of the Blue” investment strategy.  I have been highlighting large capitalized companies whose share price, for one reason or another, has fallen below EBV-3 (see Economic Book Value under Key Concepts), our last EBV line we color blue, with a subsequent rally – sometime later – transiting above this same blue line or EBV-3.  We at Acker Finely colloquially term this investment strategy “Coming out of the Blue”.

I am not making any specific stock recommendations with these blog posts, as I have mentioned numerous times.  My purpose is to highlight teachable situations so you can learn our unique financial algorithms and apply them to your own investments with the possibility of helping others who want to learn and follow this work.

One company that caught my eye this week was Cliffs Natural Resources – CLF.

Cliffs Natural Resources – CLF

As always let’s start with our model price chart on CLF.

Cliffs Natural Res with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

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

As you can see CLF had a negative transit into EBV-3 mid-March of this year.  As a rule I never fool around with companies that have a negative transit of EBV-3.  I recommend, generically, with all investment situations when they do have a negative transit of EBV-3 or as we say “Going into the Blue” the investment should be sold.  As a warning it is not uncommon, even when dealing with large cap equities, that companies can go bankrupt or never re emerge as a healthy company once this EBV line is crossed.

The opposite is true when a company has a positive transit of EBV-3.  A positive transit of EBV-3 is a signal the company and its stated assets on the company’s balance sheet has value or is gaining value in the eyes of the public marketplace.

For reference I have also included our long-term model price chart on CLF for the last 7 and half years.

Cliffs Natural Res with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

You can see that CLF traded as high as EBV+7 in 2008.  One of the many advantages of using our EBV lines, is they represent a constant to the company’s ever changing balance sheet.  So EBV+7 of 2008, can be compared to EBV+7 of today based on the company’s latest balance sheet.  You are comparing apples to apples – fundamentally.  Again this is NOT technical analysis that unfortunately our work is easily confused because our fundamental analysis is in chart form.

So for fun, and I realize this number is not on our model price chart (and hard to figure since our charts are logarithmic, but would be above $241 figure on the left side of our model price chart), what would CLF be trading at if the stock were at EBV+7?

Would you believe $278.16!

In other words, investors were paying $278.16 for CLF (merchandise) that today costs $23.15!  In my mind $278.16 is the “retail” price and $23.15 is the “wholesale” price.  I’m making this determination based solely on the EBV levels and NOT on our calculation of model price.

Looking at our long-term model price chart again, CLF almost traded to EBV+5 in 2010 and 2011.  Again, comparing apples to apples if CLF were trading at EBV+5 today that would mean a price of $129.93.  Still a big difference but obviously not as great as CLF was trading at EBV+7.  This is valuation explained.  At what EBV level gives you the best chances of success investing your hard earned dollars.  That’s right, our last EBV line, EBV-3 the bottom blue line.  If you’re investing in companies at this level, EBV-3, that’s “wholesale” pricing in my mind.

I love investing “wholesale”.

I think people are born to purchase equities at “wholesale” prices.  It’s a mentality.  Yes, the analysts hate the stock.  The business press will simply ignore the company or use it as an example of what NOT to do for various reasons.  But if you just focus on the math, you will be OK with your own investment judgment.

Myself, I just purchased some CLF at $21.34US that some investors were paying $278.16 for back in 2008.  Can you imagine this?  Same company.  Same management. How is this possible?  Who cares!  Investors are throwing out the trash and I’m dumpster diving.

You don’t have to put your whole portfolio in this name.  That would be too much risk.  Why be risky?  As these large cap stocks have a positive transit of EBV-3 just put some in your portfolio.  Say 2 to 5%.  Forget about it.  If the stock has a negative transit through EBV-3 sell the position, as I mentioned earlier.  Easy.  When do you sell?  Whenever you want.  How about EBV+7?  How about EBV+5?  Do you really care?

“Coming Out of the Blue” is about buying “wholesale” and waiting for your merchandise to achieve “retail” pricing.  If you’re going to make 200 to 700% on your investment do you really care how long this re pricing takes?  I know I don’t.

Do you buy stuff “retail” or “wholesale”?

P.S. All of the “Coming Out of the Blue” blogs on various stocks have been doing quite well.  Have a look at First Solar (FSLR) that I highlighted back on November 28, 2012.  FSLR is up 80% since my blog post.  Do I care?  With so many “Coming out of the Blue” names – lots of eggs in lots of industry baskets – maybe I never sell the position.  Who Knows?  Since I purchased FSLR at the right price (wholesale prices) do I really care?  Not me!

P.P.S.  Since its May and the business press is filled with articles on the wonderful sophistry of “Sell in May and go away” illogic, let me revise this quote and say, “Buy ‘Coming Out of the Blue’ stocks and go away”.

P.P.P.S. As Mark Eaves points out on our Model Price Application on Facebook – Comments Section, Citigroup is close to having a positive transit of EBV-3.  I am NOT making a security recommendation here however this will be bullish for Citi, the equity markets and subject of “Coming Out of the Blue” future blog post.  Yes, sometimes I can see the future – and so can you!

If interested here are some links to other “Coming Out of the Blue” blogs I have written.

Question and Answers about “Coming Out of the Blue”

How Jumbo Returns are Possible – Part 1

How Jumbo Returns are Possible – Part 2

What is wrong with BlackBerry? (Part 2)

I wrote a blog on Sunday, highlighting my curiosity with the trading of BlackBerry shares.  (here)  My curiosity can be distilled into the following question, “Why can’t BlackBerry have a positive transit of EBV-1 or $15.76 US?”  Well yesterday (Monday, May 6^th, 2013) provided an interesting example of what I’m talking about.

I have reproduced Monday’s trading action to illustrate my point.  Below is a snap shot of my Bloomberg for the daily trading action of BlackBerry (BBRY).

Intraday pice action of BlackBarry for Monday, May 6, 2013

 

You can witness yourself the struggle the stock is having with our Economic Book Value (EBV) line.  BBRY certainly trades above our EBV-1 line intraday however the stock price cannot close above our EBV line – illustrated above.  This has been on battle that has occurred on three separate occasions since mid January that I have pointed out in my previous blog. (here)

What to make of this price action?

There maybe good news on BlackBerry from the analyst community, but the stock is certainly struggling here at this EBV level.  BBRY was one of my original “Coming Out of the Blue” stocks (here) and still is unless the stock has a negative transit of EBV-3 anytime in the future.

To me, the market is saying BlackBerry will survive in its current form.  But in terms of valuation, the market isn’t even giving the company a valuation commensurate with the company’s accounting book value and this is surprising.  This shows that BlackBerry needs to do a whole lot more in the marketplace to compete with Apple and Android before any additional valuation to given to this company.

What is Wrong with BlackBerry?

This question has been plaguing me for weeks.  What is going on here?  Even the noted bear on the stock from Jefferies, analyst Peter Misek, who questioned BlackBerry’s survivability at one point last year and now rates the company a buy with a $22 price target, says that sales checks on the Q10 “indicate broad sellouts” and he continues “Based on our store checks, the BlackBerry Q10 has been selling extremely well and has been sold out or seeing limited availability in Toronto and across the U.K.”

This sounds positive doesn’t it?

Well let’s look at the model price chart of BlackBerry and it tells a slightly different story.

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

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

As you can see BBRY has been trying to have a positive transit of EBV-1 or $15.76US on three separate occasions since mid January of this year.  It even tried last week but to no avail.  All this price action is occurring under our definition of the book value of BlackBerry’s balance sheet.  See our definition of book value is our green line or Economic Book Value (EBV), is different from accounting book value.  Even using the conventional accounting book value that we calculate to be $18.14 is above BBRY’s trading action.

So here is my issue with the trading action of this company.  Certainly to my mind BlackBerry should be trading at least at book value, whether our definition (EBV) or the accounting profession’s, and it can’t even transit through EBV-1.  Since the launch of Z10, and now the Q10, no one questions BlackBerry’s survivability does it?  Not that I have seen in the financial press.

Here is a company that will make money this year, solvent and with some analysts predicting big earnings in the coming years and it’s trading like a “dog”!

Something is certainly going on here and I wish I knew why?  Maybe BBRY will have a positive transit of EBV-1 in the near future and all my suspicions and questions are moot.  I would feel better about this Canadian company if there was a positive transit of EBV-1 and trade at least at EBV or our green line if things are so groovy as Peter Misek suggests.

As always time will tell!

May 2013 – Monthly S&P 500 Market Strategy Update

Talk about a market rally!  (US equity market that is!)  Since mid November 2012 the market, as measured by the S&P 500, has rallied almost 18% to May 1, 2013.

As I have been noting in my “Monthly Strategy Update” blogs, I have been foolishly calling for a correction as my most likely scenario.  Well, so much for this most likely of my guesses. (see blog)

Let’s first review our model price chart of the S&P 500 Index.  First our short-term model price chart (weekly price bars).

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

For perspective I have included our long-term model price chart (monthly price bars).

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

Remember 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.

S&P 500 Positive Transit of EBV+3

As you can see in the above model price chart the S&P 500 had a positive transit of EBV+3.  This is AMAZING and we should stop and ponder its implications.  Our EBV levels are about valuation.  Collectively in a capitalized weighted index known as the S&P 500 equity prices are increasing in terms of valuation – equity asset prices are increasing.  Whether this is occurring because of corporate profits, good government policy or market participants searching for yield does it really matter?  Some market professionals think there are negative reasons for this unexplained (according to them) market rise but I would like to point out these persons exist in every market cycle and receive considerable ink from the financial press.

As I have stated in previous blogs this is the first time the S&P 500 Index has had a positive transit of EBV+3 since mid 1992.  Our long term chart unfortunately doesn’t go back this far, and you have to take my word for it, but you can see from our model price chart how the market increased from 1995 to 2000 subsequent to the positive transit of EBV+3 in mid 1992.  Am I saying this will occur again?  What I am saying is you have to think of this possibility – the possibility of a long-term secular bull market in US equities.  Is there anyone else saying this?  No one I know!

Risk and Reward

Markets and individual stocks are about risk and reward.  Obviously good investors want to minimize risk, wherever possible, and maximize reward.  This is what our EBV lines are all about.  Making purchases close to support or our EBV line minimizes possible downside risk in that if there were a down transit of this same EBV line this would be an excellent sell point for your position or investment.  In other words market prices don’t have to fall very far to let you know the position should be sold thereby not placing a significant portion of your capital at risk.

What am I saying?

The risk and reward of the US equity market has changed.  With the S&P 500 Index trading above EBV+3 the risk is minimal and the reward is EBV+4 or 1980 in the above S&P 500 model price chart.  That’s an upside of a further 25%.

Even if the market trades along EBV+3, this implies a return of 10.5% plus dividends.  (How did I get 10.5%? EBV+3 one year from May 1, 2013 is 1749.  We get this number by inputting all the balance sheets of the underlying companies in the S&P 500 Index, add estimated annual earnings on a bottom up basis less projected dividends for the year and calculate EBV+3 one year hence.)

Traffic Light turns Green!

Back in a blog post last August (here) I started to use a traffic light analogy in terms highlighting and/or quantifying the risk level for investors/traders.  In my initial assessment I thought the traffic light should be yellow to signify caution.  Why?  The S&P 500 Index traded under EBV+3 signifying limited upside (to EBV+3) and a big downside to EBV+2.  Now, with the positive transit of EBV+3, the downside risk is EBV+3 and the upside is EBV+4, some 25% higher.  I do have to emphasize these general market calls which I blog about are secular (long term) in nature and will last until the market moves significantly higher changing the risk and reward characteristics which I have highlighted above.

What if the S&P 500 has a down transit of EBV+3?

The S&P 500 potentially could negatively transit below EBV+3 for a period of weeks maybe a few months, in what I call a “break out pull back”.  A “break out pull back” formation is common in model price work and very bullish when there is a “re break out” or a positive transit of EBV+3 for a second time.  Traders can be quick to make profits from such an event, but long-term investors should ignore such market gyrations and hold quality equities for the long-term.

Conclusion

For the month of April, 2013 the S&P 500 Index had a positive transit of EBV+3.  This is an historic occasion in our model price work and noteworthy.  The traffic light is “green” in that the risk and reward for long-term US equity investments is heavily skewed towards the reward side of the ledger.  In other words, the proverbial wind is at your back when choosing quality US large cap companies.  This could be the beginning of a secular run in US large capitalized equities that could last years.  And of course this positive transit doesn’t preclude some future hiccups in terms of monetary policy, and a million other macro considerations that have yet been imagined or forecasted but the market is speaking to you and it’s saying as of today and the foreseeable future all is well!