September 2013 – Monthly S&P 500 Market Strategy Update

The war drums are pounding.

To ‘taper’ or not to ‘taper’?

This month, September, we get to know the new nominated chair of the Federal Reserve Board to replace Mr. Ben Bernanke.

What to make of this market?

Everyone seems to be confused.  Bearish views and news seems to be everywhere.  ‘Tapering’ seems to be the topic of every business newspaper and television program on the planet.  Even a few portfolio managers are getting into the act.


What does Model Price say?

Everyone calm down, everything is fine.

Let’s have a look at the S&P 500 through the filter of our model price chart.

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

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

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

As you can observe the US equity markets, as defined by the S&P 500 Index, is following a logical pattern.  First the market had a positive transit of EBV+3 back in May of this year. (Blog).  The market rallied to new highs in May with a pullback to the end of June.  In July the market rallied again to new highs and pulled back to the end of August.  This pattern or saw-tooth action could occur for quite sometime while the ‘BIG’ issues the market is facing, whether real or made-up by the financial press, are resolved.  Plus we have had tremendous gains year to date especially in the financial stocks and selected growth companies like Netflix and Tesla, so some consolidation maybe in order.

The good news, as you can see from the model price chart above, our EBV (Economic Book Value) lines are sloping in an upward direction.  This is compounding at work for investors.  EBV+3 one year from the month of September is 1764.  (How do we do this?  From a bottom up basis we add all the earnings less dividends to all 500 companies and project out what EBV+3 will be on a pro forma basis.   Of course we cannot anticipate any future corporate activity like stock buybacks, M&A activity and other future corporate news that could change balance sheets materially over the period.)  So from the close on September 3, 2013 of 1639.77 to 1764 – EBV+3 Pro forma September 2014 – represents an increase of 7.6%.  Not great but not bad either.

What is the risk in US equities?

Defining risk can mean a lot of things to a lot of people.  But here at model price defining risk and reward is as simple as looking at the value of the zone the equity or market trades in.  What are the numbers to the S&P 500 Index zone?  For the month of September EBV+3 is 1595 and EBV+4 is 1995.  So as of September 3rd close (1639.77) the S&P 500 has a risk or downside of 2.73% and an upside of 21.66%.

The calculated model price risk/reward scenario is very positive for US equity investors no matter what the issues real or imagined that face this equity market.


Everyone seems to have an opinion on this US market.  Is anyone in the financial press overly bullish here?  Not the financial press I have read anyway.  Could the S&P 500 have a pull back to EBV+3 or 1595 or 2.7% lower from the September 3rd close?  Absolutely!  Would this be a great entry point for long only investors who wanted to get into this market at a favorable valuation level?  Absolutely!

EBV+3 represents a floor under the US equity market that is formidable according to model price theory.  Could the market have a negative transit of EBV+3 in the next few quarters?  Sure, but the probability is low.  Actually the higher probability, believe it or not, is for the S&P 500 Index race up to the top of the zone or EBV+4 (1995).  But hold on, what if the market takes a year to reach EBV+4?  We calculate EBV+4 in September 2014 to be 2206.  Yes, that’s some 35% higher then the September 3rd close of 1639.77.  Can you image the US market tacking on another 20 – 35 percentage points of performance after the gains already accrued since March 2009.

The good news about Model Price Theory (MPT) is presenting to you what is possible/probable in terms of risk and return and upside and downside percentages for your investment plan or strategy in all deference to Mr. Gross and the financial press.  To say it bluntly the risk investors face is NOT being in the US equity market and enjoying the possible gains on a secular basis.  In other words, there is more easy money to be had.

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