It has been awhile since I talked about the Canadian equity market through the filter of an index so let me remedy this oversight with this blog. The equity index we commonly use is the S&P/TSX 60 Index. This index contains the largest capitalized companies in Canada.
Let’s start with our short-term model price chart of the S&P/TSX 60 Index.
S&P/TSX 60 Index with weekly price bars and EBV Lines (colored lines).
As a reminder we aggregate all companies in the S&P/TSX 60 Index into one chart on a market capitalized basis (like the index itself), so we can see where the market – S&P/TSX 60 – is trading relative to its EBV lines.
Observables from the above chart
1. As I have annotated on the above chart, the S&P/TSX 60 Index closed at 767.76 on Monday, November 4th, 2013. Our calculated EBV+2 is 787, which is only 2.5 percentage points higher. The lower zone or EBV+1 is 657 or almost 15% lower.
2. The first half of 2013 was very lackluster for this Canadian Index as emerging country share prices were hit by the anticipation of the US Federal Reserve (FED) ‘tapering’ its bond-buying program starting in September of 2013. From the index lows of the last week in June (677) this index rallied over 13 percentage points in four months as the FED reversed course and delayed its ‘tapering’ maneuvers until sometime in 2014.
3. Canadian share prices are heavily influenced by US equity valuations and equity market performance. This shouldn’t be a surprise to anyone participating in Canadian shares. As US equities prices continue their upward climb so will Canadian share prices pushing the S&P/TSX 60 Index through EBV+2 – positive transit – giving Canadian equity investors a target of EBV+3 in terms of valuation.
Long-term look at the S&P/TSX 60 Index
To help readers with some historical perspective I have included our long-term model price chart going back some 18 years.
S&P/TSX 60 with monthly price bars and EBV Lines (colored lines).
Highlighting a couple of items on our long-term chart.
1. You can see the impact of Nortel and BCE (Parent of Nortel) on our EBV lines back in 2000. The big increase in our EBV lines represents the large balance sheet of Nortel and the market weight of this one stock on the S&P/TSX 60 Index. The subsequent fall in the same EBV lines represents write-offs on Nortel’s balance sheet and fall in market cap – mathematical influence – in the same index.
2. The second observation is the valuation high this index achieves over a long period of time. The maximum valuation is EBV+3. Sure the index can stay at EBV+3 for a length of time however EBV+3 is as high as this index goes. If in the future this index achieves a valuation of EBV+3 caution is warranted. Conversely if the S&P/TSX 60 Index declines to EBV (Green Line), again anytime in the future, this would be an opportune time for market participants to increase their exposure to the Canadian equity market.
Model Price Theory (MPT) takes a unique approach to looking at valuation levels not only with regards to individual equities but also to equity indices. The Canadian index S&P/TSX 60 will probably transit EBV+2 especially if the US equity markets remain strong. Also sometime in the future this index will probably achieve a valuation level of EBV+3. This valuation level will probably signify the maximum level the S&P/TSX 60 will achieve irrespective of the possible good economic news on both sides of the border. The issue for investors will be timing as you can observe the index hugged EBV+3 for a number of years, starting in 2005 until the financial collapse of 2008.