Monthly Archives: January 2014

Yahoo’s Marissa Mayer – One of the Best CEO’s in the S&P 500!

Am I clueless!

The market and the haters seem to think so.

But according to the Model Price Theory (MPT) math she is doing all the right things.  Sure the market didn’t agree with my assessment – at least on Wednesday – sending the stock down over 8%.

And the haters, they are everywhere.  I guess that’s what Twitter is for …expressing one’s outrage!

What was the headline reaction from the mainstream business press on Yahoo’s 4th quarter?  “Marissa Mayer’s attempt to turn around Yahoo Inc. is struck in neutral.” reported the Wall Street Journal.  The other headlines and business stories were less favorable in their reaction to Yahoo’s closely watched slightly declining display-ad revenue.

Clearly she placed displayed-ad revenue in the hands of her Chief Operating Officer, Henrique de Castro, one of her first hires, who she summarily fired when the quarterly results became evident several weeks ago.  Mayer’s haters went into full chorus cries over the expense of such hire – fire decision over a 15-month period but you have to admit for the rest of the employees in the Yahoo organization this action probably got their attention.

So what does ModelPrice Guy see that’s so different then anybody else?

I was shocked when I saw the number.

When our computers finished calculating the numbers on Yahoo’s balance sheet the Theoretical Earnings (TE) came in at 93 cents.  Back in 2013 Yahoo’s TE was almost as high as $1.40.  That’s an incredible 33% reduction in TE.

I know what you are saying?

“I have no idea what Theoretical Earnings (TE) are (and nobody else does either) and why do I care whether TE goes up or down?”

The stock market cares!

Remember Theoretical Earnings (TE) is our calculation of what a balance sheet ‘in theory’ should produce in terms earnings.  Every balance sheet can produce this theoretical number irrespective of the company and what they produce.  This financial concept, Theoretical Earnings, is one of the foundations of Model Price Theory (MPT) and unique when thinking about financial analysis.  For more detail see ‘Key Concepts’ tab for more information.

So let’s have a look at the data.

image00111

My first chart shows our calculation of Theoretical Earnings (TE) of Yahoo since the company went public.  We compare our calculation of TE with the 12-month forecast of Yahoo’s earnings.  Generally over the span of the company’s history as the TE expanded, or move upward, so did the earnings of Yahoo.  This should make sense.  As the assets increase on the balance sheet of a company the earnings should as well.  Just like a bank account.  As the savings value increases so does interest earned on the account.

Another way of viewing the data is taking the two series in the above chart and combining them into a ratio.

image0035

Here you can see the ratio of Earnings per Share (EPS) over our calculation of Theoretical Earnings (TE).  More importantly look at this ratio since Ms. Mayer has become CEO of Yahoo, Inc.  In all of my work with large capitalized public companies I don’t think I have seen this ratio rise as fast as this.

What does this mean?

An increasing ratio of EPS/Theoretical Earnings means Ms. Mayer has not only significantly grown earnings since her arrival as CEO but also has shrunk the amount of capital in the business as our TE calculation shows.  In other words she is producing more earnings with less capital.  This is what CEO’s are supposed to do, but rarely seen.  Ms. Mayer is special in that she seems to get this fundamental mathematical aspect of leading a company and increasing the share price for investors/shareholders.

But why didn’t the market NOT like Yahoo’s 4th quarter earnings release?

This happens quite a bit in the equity markets.  Yes, so much for the Efficient Market Hypothesis.  Investors, analysts and traders tend to focus on the wrong metric.  In Yahoo’s case it’s the analysts’ focused display ad-revenue.

Yahoo has been a dog of a stock for quite sometime but there is a turnaround happening.  The same analysis that shows you a turnaround also shows why Yahoo has been underperforming.  In the chart above the ratio between EPS/Theoretical Earnings has been going down to flat since 2005.  One can see the change in the ratio since Ms. Mayer has taking the helm and it has been dramatic.

Conclusion

We have model price data and charts on every company in the S&P 500 in our database.  Is there one CEO in the whole population that is turning around a company as fast as Ms. Mayer?  Nope.  That’s why I have crowned her one of the best CEO’s in the S&P 500.  She seems to get the math, intuitively.  Nobody, and I do mean nobody is giving her any credit for this dynamic turnaround, except for me of course.  Everyone seems to think the stock price of Yahoo is going up because of Yahoo’s 24% ownership position in Alibaba.  Alibaba maybe the focus of investors/traders but they are missing an amazing story going on at Yahoo, the company itself.

As I admitted in my first blog about Ms. Mayer, I am a fan.  I had a feeling and anticipated that she would be a CEO to watch.  As time passes and the model price math becomes apparent I see my confidence has not been misplaced.  Hopefully we are in the early days of her tenure at Yahoo and shareholders in the company are in for a long and profitable run.

See our Model Price chart below;

Yahoo, Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Yahoo, Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

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

In a Year of Multiple Transitions: This one is the most Important to your Financial Health!

While the world’s elite gathered in Davos drinking champagne and giving each other backslaps on saving the world from depression, the world equity markets roared back into the headlines on Friday (January 24th, 2014) by dropping suddenly with triple digit losses.

Is there any cause for concern?  What is going on?  Well, Model Price Theory (MPT) to the rescue.

Do you believe in leaps of faith?

Well this is where the US economy is right now.  And the world financial markets are preparing themselves.

What do I mean by leap of faith?

2013 will go down in the history books as a transition year for the US federal government.  From shutting down the government to budget sequestration the budget deficit forecast for this fiscal year (October 2014) will be 3% of GDP.  Roughly in line with projected US growth of say ±3%.  Down from a high of almost 13% in 2010.  This is a big accomplishment and the equity markets have rewarded this behavior with substantial gains.

The $64 million dollar question is whether the other economic actors in the US economy namely non-financial companies, financials, consumers and state/local governments get a sudden surge in confidence about the fiscal prospects to start spending/investing driving the US economy forward.

This is the leap of faith and it’s a biggie!

This is where the US equity markets are at present.  Fiscally, after tremendous amounts of stimulus to keep the US economy from entering depression, the US government is back on track of budget deficits in the $300 to $500 billion range for the foreseeable future.   In other words, the federal government has done all it can and wants to do to assist the private economy.  Monetarily, the Federal Reserve will start to ‘taper’ its bond purchases this month withdrawing its support of asset prices called ‘Quantitative Easing’ or QE.

Something like starting a car on a cold winter morning!  Will the engine ‘kick’ over or not?  After years of massive government support will the economy start to function normally again, pre 2008 financial crises?

This is how I interrupt recent global equity market and currency declines.  Investment dollars are leaving emerging market hot spots (including Canada) and migrating back to the US.

In terms of timing and future economic growth, it’s an interesting place to be, for investors.  Global equity markets are pricing in this lull between a government supported economy and a normal functioning economy without government support.  How do the global markets price this uncertainty?  Simple, they all go down – as we are currently seeing – and as fundamentals improve investors will drive stronger economies both equity and currency markets to new highs.  Leaving weaker global markets lower and investors with negative rates of return.

For those wanting more Model Price Theory (MPT) here is what I see.

Here is our ‘Solvency Curve’ that I introduced back in a blog on July 17th, 2012.

Solvency Curve - See Key Concepts for Description

Solvency Curve – See Key Concepts for Description

The US federal government – left hand side of the curve – has now stabilized its solvency at 0.135 or on the cusp of the 3RD Order of Insolvency.  As scary as this sounds – it’s OK.

The other economic actors – on the right hand of the curve – should start to move upward – becoming more balance sheet efficient – as consumers re-lever (start taking on debt after five years of deleveraging); nonfinancial companies with a record amount of cash – close to $2 trillion – start to make capital investments and grow top line sales and US global banks busting with excess reserves start to invest in a growing economy for higher rates of return on capital.

This virtual circle of economic activity should continue as investment spending and job creation will support future economic growth driving equity values higher.

What is my opinion?  Count me as a believer.  The US endured one of the largest financial and economic declines since the Great Depression.  Federal government policy actions both fiscally and monetarily were effective and innovative.  Sure Washington looked dysfunctional at times but the hard and necessary work got done.  The global equity markets are now realizing this reality and shifting investment dollars as a result. The US will recover as world’s economic leader where they have been noticeably absent over the last 5 years.

And that’s a good thing!

P.S. For a more detailed account of possible ‘Transitions’ for 2014 see our Acker Finley 4th Quarter (Year End) newsletter called “Transitions” here.

P.P.S. For a more in-depth review and ongoing discussion on our ‘Solvency Curve’ and the US economy over the last two years here are the applicable links.

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)

Both S&P/TSX Composite and S&P/TSX 60 having a Positive Transit!

This is a positive.

Yes, I know the Canadian dollar has been getting slammed but our Canadian equity market likes what’s happening.

Let’s have a look at both indices, S&P/TSX Composite and the S&P/TSX 60 to see what is going on.

S&P/TSX Composite

Model Price Chart

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

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

 

As you can observe from the above chart the Canadian market rallied up to EBV+2 back in October and November of 2013.  Had a nice pull back in December and rallied through EBV+2 in January.  Yes, it’s hard to see – a little nub on the chart – but the market is sniffing the air in a different higher zone making Canadian equities attractive on a risk/reward basis.

S&P/TSX 60

Model Price Chart

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

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

 

To my mind it’s always great to have confirmation of a price or index move.  Well the same positive transit occurred on the large-capitalized Canadian index, the S&P/TSX 60, as you can see above.

Conclusion

The Canadian equity market is having a good January – so far.  Even though our equity market has been lagging behind the S&P 500 – valuation wise – this positive transit is a signal that fundamentals are improving for Canadian companies.  In order for each respective Canadian index (mentioned above) to reach EBV+3 all sectors of the Canadian equity market have to participate.  The obvious sectors to play ‘catch-up’ are the 2013 lagging sectors, principally Oil and Gas and Materials (gold) sectors.  Global economic growth should help these lagging sectors play ‘catch-up’ in 2014.

Could both indices have a negative transit of EBV+2 in the near future?  Absolutely.  However the subsequent positive transit would be very bullish, qualifying this formation as a ‘Break-out Pull Back’ – one of my favourite formations.  In other words, the above indices have a positive transit – that has already occurred – a correction, sending each index below EBV+2 and having another positive transit of the same EBV+2.  To me this would confirm that the Canadian equity market clearly believes, valuation wise, it belongs in the zone between EBV+2 and EBV+3 giving investors future positive rates of return.

Who uses Weekly and Monthly Bar Charts? (Reblog)

(On this slow trading day – Martin Luther King holiday – I thought I would reblog an earlier blog post on why I use weekly and monthly hi – lo trading bars on our model price charts. Also you should consider how ‘different’ you are in your research and trading style to maximize your trading and investing profits.)

“Be different”.

I will always remember these words.  See I was in Austin, Texas in August – the heat was unbearable – in the late eighties at the elbow of a famous commodity trader, observing and learning.  He had a leased telephone line to the floor of the Chicago Mercantile Exchange (CME) trading S&P 500 futures contracts.  Every once and a while, he would switch his charting software from 5 minute price bars to 7 minute price bars.  And if trading profits were slim he would change to a 15 minute price bar.  He explained if all the traders were using the same price bar trading profits were nonexistent because everyone was acting on the same bar and the boys on the trading floor were fading (taking the opposite position) against the trading masses.

On a another occasion I was in Incline Village, Nevada just outside of Lake Tahoe, at a famous commodity trader’s home.  He welcomed people from all over the world to witness his trading style in the living room of his house.  He was a trend follower, who fashioned himself after the famous “Turtles”.  He planned his trades during off trading times.  Before the market opened he placed his trades with his personal floor broker in Chicago.  During market hours he invited his visitors to sit cross-legged in his living room humming Indian hymns while he beat a drum.  After the markets were closed, he would call his broker for a rundown on his trades and plan for the next trading day.

Pretty different!

See being different wins.  Warren Buffett is different.  He tells everyone, and I mean everyone what he is investing in.  One would think there would be thousands of Buffett’s doing exactly what he was doing in terms of investing.  I’m sure many try to emulate his style, based on his financial disclosures however in the end they seemingly all give up because they don’t have the discipline to follow through.

Who uses weekly and monthly charts?

Nobody!

Weekly price bars are my favorite.  I see so much.  I see supply and demand. (Look for the right tick mark in relation to the left.  Right tick higher then the left, demand in control.  Left tick mark over the right supply in control – at least for the week.)  I see variability.  How long is the vertical of the price bars.  Long verticals mean volatility, short and stubby mean peace and quiet.  What has been happening in the last few weeks or the last fifteen weeks?

I’m sure I’m the only guy on the web producing customized stock graphs on my blogs and Twitter accounts with weekly and monthly price bars – if you know of anybody please let me know.  Hopefully this gives my readers and followers a different perspective from the usual daily charts offered and analyzed on the web.  I have seen many canned software packages offering technical analysis that I have to admit look pretty slick and with beautiful colors!  It reminds me of the fishing lure joke, where an out of town fisherman was looking at a beautiful fishing lure and asked the store owner whether the local fish would like the lure.  The storeowner shrugged and commented that he didn’t know; only fishermen purchased the lures and not the fish!

As you can see my model price charts are programmed special for my use.  I want no frills, just the striped down version, and the bare essence of the simple price bar.  Simple is best.

What trading tools are you using?  Are they different from the trading hoards?

At least you can say one thing about the material I’m producing in this blog and how I analyze individual stocks in relation to others on the web – I’m certainly different!

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

(J. Michael Pearson is now a billionaire!  So the title of my original blog is a little off.  Back on September 13th, 2012 I blogged about the company Valeant Pharmaceuticals International Inc. (VRX) when the stock was trading at $56 USD.  Friday, January 10th VRX closed $133.50 USD.  What is going on here?  Well I explain it all in my original blog back in September 2012.  A body in motion stays in motion, Newton tells us and J. Michael Pearson is doing exactly this.

Rolls ups are fun to watch and profitable if an investor knows what is going on and you have the right jockey (CEO).  Thankfully we have been part of the move (Acker Finley), but ‘tress don’t grow to the sky’.  In roll up situations the law of large numbers finally catches up to the consolidator, in this case VRX.  Have we reached that point in time?  We will have to wait to see what acquisition Mr. Pearson pulls off to keep up the growth the market now expects along with our calculated Model Price Theory math of course.  Again, this should be interesting to observe.

I have updated our chart (analysis) showing expected earnings of Valeant (one-year forward) with our calculation of Theoretical Earnings (TE) that I included in my original blog for all to see.

image00110

If Mr. Pearson can make future acquisitions keeping the ratio between Theoretical Earnings (TE) and EPS intact – or better still expanding – the market, I’m sure, will reward shareholders tremendously – as it already has.  The antithesis is also true.  If future acquisitions inflate TE significantly without a proportional increase in expected earnings the share price of VRX will be adversely impacted.

Mr. Pearson is one smart cookie and rightfully a billionaire.  Very few CEO’s have this ability and the market is giving its blessing on VRX’s growth strategy with a positive transit of EBV+6 (see model price chart below).  This will be interesting to watch.

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

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

Valeant (VRX) – Rollups, Math and How to Become a Multimillionaire! – Reblog from September 13, 2012

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.

I’m on Market Call!

On Tuesday, January 14th 2014, I will be on the television show Market Call on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Michael Hainsworth.

Take this opportunity, open our Model Price Facebook application and follow along while I’m on the show answering viewer’s questions about individual stocks.

Would you say anything different based on your interpretation of Model Price Theory (MPT) and chart?  You can make your comments via Facebook.

Should be fun!

January 2014 – S&P/TSX Composite Market Strategy Update

 

I haven’t blogged about Canada for a while, so let’s have a peek.

First, starting with our model price chart of the S&P/TSX Composite Index.

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

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

Observables

1.  You can observe the S&P/TSX Composite Index hitting resistance back in the last week of October 2013.  After six weeks of ‘pounding at the door”, the Canadian market had a pull back in the middle of December – as annotated on the above model price chart.

2.  After the market pulled back in the middle of December, the Composite Index rallied back up to EBV+2, hitting resistance again.

3.  Newbies ask all the time, skeptically of course, whether our EBV lines work.  How perfect is this example?  Notice the lack of volatility in the market Index as it tries to squeeze its way through our calculated EBV level.  As you can observe from the above model price chart ‘something’ is preventing higher Index values being achieved.  Coincidence?  I think not!

4.  Clearly the S&P/TSX Composite wants to have a positive transit of EBV+2.  It can and will ‘pound away’ until the index is ready to achieve a positive breakout.  When will this occur?  I have no idea, but I have to admit it’s fun watching.  Isn’t it!

5.  Let’s get into some numbers.  EBV+2 for the month of January is 13,725.  EBV+1 is 11,533 with EBV+3, again for the month of January 2014 being 18,951.

If the Index does have a positive transit of EBV+2 – which seems likely – EBV +3 would be the next target for the index some 38% higher.  This possible future transit would give the Canadian equity market – S&P/TSX Composite Index – a good risk/reward for investors.

Conclusion

The S&P/TSX Composite Index is ‘pounding away’ under EBV+2.  If the US equity market – S&P 500 Index – pushes higher this will give the Canadian market impetus to ‘push’ through our mathematically calculated structural level EBV+2.  Readers should be looking at market Index levels for this possible transit.  This possible transit would be very bullish for Canadian equity investors with close support levels from EBV+2 and an upside target of 38% or EBV+3.

January 2014 – Monthly S&P 500 Market Strategy Update

Let’s contemplate the future – economically speaking!

As president and chair of the board at my local golf course some years ago I made the observation that it’s not the one or two big decisions that a general manger makes during the summer season that made the annual break even budget fall into line with the actual revenue and expenses.  It was the general manager’s daily decision making, the small and numerous decisions, that carried the day.

The same is true with our open and complex economic systems.  Hundreds and thousands of decisions are made daily by policy-makers and government officials that cumulatively could have massive impacts on economic growth for each country participating in the global economy.  And size does matter.  Favorable or unfavorable policy decisions in the United States, China, Japan and the European Union have a large impact on worldwide economic growth.  Which of these mostly secret decisions will have a positive or negative impact on economic growth, we as market observers, will never know.

As I said in earlier blogs, individual markets, especially equity markets, are about feedback.  Good economic policies provide a backdrop for positive economic results.  When the economic tide is rising this helps everybody globally.  Combining a good economic backdrop along with a company gaining market share provides a stimulus for healthy stock gains in the future.  This makes sense.

The issue I have with market punditry is the predictability of market forecasting.  Can anyone confidently predict the future when hundreds of thousands of daily decisions on economic policy that could have huge impacts on feedback mechanisms, like equity and treasury markets (interest rates), that coincide with the time frame of said prediction?  Yes, the combinations and permutations are mathematically endless.  Therefore in my mind economic and market related predictions and forecasts are useless.

So if one cannot predict the future with any accuracy, from a top down perspective how about from the bottom up?

Huh!

This is the basis for Model Price Theory (MPT).  By observing the feedback of primarily equity markets a MPT user can gain confidence on the economic road map ahead.

Want a good example of this?

Back in April of 2013, the S&P 500 had a positive transit of EBV+3.  Here is the conclusion of my blog that I wrote back in May 2, 2013.

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 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!

From a bottom up perspective, looking at all the companies in the S&P 500, through the S&P Index itself, the US equity markets were providing feedback to users of Model Price Theory (MPT) that all was well, economically speaking of course.  Could I or anyone else predict this positive transit?  No.  But, of course, once there was a positive transit of EBV+3 by the S&P 500 an easy ride in terms of market gains was indeed predictable.

Don’t tell me about the past, what about the future hotshot?

As always let’s start with our model price chart of the S&P 500 Index.

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

S&P 500 Index with weekly price bars and 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.

Observables from the above model price chart

1.  Since our noted positive transit back in April 2013 of EBV+3, the S&P 500 Index has traded up to the middle of the zone between EBV+3 and EBV+4 with little to no volatility.  (Small price bars)

2.  Our calculated EBV+4 is 2040 as of January 2014, leaving a further 11.35% possible upside for the S&P Index from the market close on January 2, 2014.

3.  Our calculated EBV+3 is 1631, giving the US equity market a possible downside of 10.97%.

4.  What I didn’t annotate on our model price chart are our calculated EBV levels one year from when the model price chart was produced.  In other words, EBV+3 is projected to be 1800 in January of 2015 and EBV+4 is estimated to be 2252.  Even if the S&P 500 stalls and consolidates mid way through the zone, market support in terms of EBV+3 is constantly rising reflecting the growth in the balance sheets of the companies.  (An market optimist can forecast a rise in the S&P 500 over 2014 to be 23% – from the market close on January 2 of 1831 to the top of the zone in January 2014 of 2252.)

Risk levels have increased, though!

So what to make of this analysis?  To me, risk levels have increased.  As I have stated back in my May blog, when the S&P transited above EBV+3 investor risk level was low.  Why?  Because market support levels were close to where the market was trading.  As the S&P 500 gets further away from EBV+3, investor risk level increases – this should make sense.

Would I get out of the market because of this increased risk?  Of course not.  Risk as well as reward must be judged carefully when making investments.  I am always mindful where this market is relative to where in the zone the market is trading.  As the market moves upward, closer to EBV+4, the possible downside risk increases while the upside gets squeezed.  As market euphoria increases MPT users will get more cautious – counter cyclical.

Conclusion

2013 was an eventful year in terms of economic political rankling.  Budget sequestration and the US Federal government shutdown gave market bears plenty of grist for negative forecasts.  The US equity markets thought otherwise.  Broadly, the economic decisions made by US policy-makers and global leaders have had a positive feedback in terms of US equity markets increasing equity valuations across the board.  This positive signal was given back in April of 2013, as the S&P 500 transited above EBV+3.

As the US equity market drives higher, as market participants get more confident, risk and reward levels have to be adjusted by the users of Model Price.  Yes, the S&P is gaining momentum and will probably reach for the top of the zone or EBV+4 in the ensuing year however risks do rise as the S&P 500 climbs higher in the zone.

Prediction of higher equity prices is a fool’s game.  If the S&P 500 were to pull back to EBV+3 (and the Index still remaining in the zone) – an implied 10% correction – nothing would have changed in my MPT analysis except for my and your favorite stocks could hopefully be purchased at lower prices.

BAC – “Coming Out of the Blue” – Marking the End of the 2008 Financial Crisis.

This is shockingly positive!

Bank of America, the US global money center bank that swallowed up the toxic mortgage assets of both Country Wide Credit and Merrill Lynch during the financial crisis of 2007-8 had a positive transit of our last EBV line or EBV-3 on Friday, January 3, 2014.

Who would have thought on a quiet trading day sandwiched between New Year’s and when everybody goes back to work on Monday, January 6th – a stub period of two days trading – that something this historic would have happened.  See you never know what can happen in a supposedly dull trading market that nothing of note should have happened.  And it did!

Why is this event so notable?

This is the last one!

That’s right.  Believe it or not Bank of America is the last financial bank in the S&P 500 that has just had a positive transit of EBV-3.  Go ahead, use our ‘Speed Charting’ tool on our Model Price app and click through all the financial companies in the S&P Financial Sector in the S&P 500.  They are all trading above EBV-3, including Bank of America.  (Only two companies are trading underneath EBV-3 in the Financial Sector of the S&P 500; Genworth – GNW and Hartford – HIG, both insurance companies.)

Will anyone call an official end to the financial crisis of 2008 – mathematically of course?  I will.  How can I do this?  Simple.  All the financial institutions listed in the S&P Financial Sector– global lending institutions and investment banking firms – that back in 2007 principally caused the financial crisis and were, in reality, all bankrupt in the middle of 2009 and revived with substantial US federal government support have all had a positive transit of EBV-3.  With Bank of America’s positive transit on Friday, the last financial institution to do so, to me marks the end of the 2008 financial crisis.

This is truly an historic moment.

Yes, some major financial institutions didn’t make it.  Yes, some of the US global financial institutions are now bigger, in terms of assets, than when they entered 2007 and are certainly “Too Big too Fail” (TBTF).  But US federal government policy, principally actions by both the US Treasury Department and the US Federal Reserve, saved the world at large from another Great Depression that certainly would have been larger and more painful than the last recorded depression in the 1930’s.

You want poetic justice.  Mr. Ben Bernanke, the chair of the US Federal Reserve Board, during the last eight years, including the financial crisis of 2008, had his ‘swan-song’ speech with one month to go in his tenure at the American Economic Association’s annual meeting in Philadelphia on Friday, January 3rd.  Yes, the same day Bank of America had its positive transit.  Who said the market does have a sense of humor?

Anyway here is the model price chart of Bank of America as at the close on Friday, January 3rd.

Bank of America with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Bank of America with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

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

I have also included the long-term model price chart of Bank of America where the company’s share price tried and failed to have the same positive transit back in the latter half of 2009 and beginning in 2010.  Clearly this time frame was far too early in the financial crisis for Bank of America to have any such transit.

Bank of America with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Bank of America with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Conclusion

It has been a long 5 plus years.  I remember nightly as the financial crisis was unfolding in 2008 that my personal and financial life would be difficult for a period of time.  Luckily I was prepared both physically and mentally for the blizzard of turmoil that came after 2008.  Doubly, I was fortunate that I had Model Price Theory (MPT) helping me interrupt the financial footsteps of policy makers that lead myself back – along with my clients – to where I was before the financial crisis started its quick and violent decline and long recovery dating back to July 2007.

For some readers of this blog, I’m sure you endured the same thing.  Welcome back!  Others, unfortunately, didn’t make it financially for one reason or another and I am sure some of you will never be investing in equities again.  (I have spoken to many in this group.)  Whatever your perspective, Friday marked the end or closing of the book in terms of the financial crisis of 2008 with Bank of America’s positive transit of EBV-3. Let’s all hope lessons have been learned by policy-markers and society-as-a-whole that the next financial crisis is some hundreds of years away.

For those unfamiliar with our unique “Coming Out of the Blue” investment strategy here are some additional links from my blog posts that may help you.

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

“Do these EBV Lines Work?”

Model Price – Conversations About EBV Lines

“Why do stocks go up and down?” (Reblog)

(I’m working away on my monthly S&P 500 Market Strategy blog for the month of January.  Over the holidays I have been rereading some of my earlier blogs.  With over 250 blog posts I realize time can be a big impediment for my blog readers, especially new readers, to read blogs I have written some time ago.  I will reblog some of my earlier blogs that are my favourites and not time sensitive over the next few months in hopes you fine them interesting and increase your knowledge of our model price work.  2013 was one of my best years in terms of profitable trading with the use of our Model Price app.  Here’s hoping 2014 will be one of your best ever with our Model Price app and our rapidly expanding community of Model Price users.)

“Why do stocks go up and down?” (Blog posted May 2, 2012)

As a teenager I was mystified how this happened.  The question of “why” never left my mind when looking at the stock tables in the newspaper.

Aren’t you curious why this happens?

I have put in my 10,000 hours.  I have seen it all.  I have studied track records of other managers.  I started reading Warren Buffet annual reports in 1984.  Warren who?  More importantly I gave up reading them in the mid 1990’s.  In the early 80’s I knew John Templeton’s track record off by heart.  Getting a Barron’s on a Saturday morning and digesting every page before the market opened on Monday morning.  I haven’t read a Barron’s in 15 years, maybe more!

I quit the accounting profession in 1985, to become a stockbroker.  In those days, I would ring up or go visit any manager of financial assets with a hot hand.  I would fetch coffee, lunch anything they needed just as long as I could sit silently in the corner and see what they did.  How they worked.  The system they used.  They were open and honest.  Those were the days.

I was on the trading floor, Sunday night, October 18, 1987, watching Jim Baker’s face and telling the world Germany would not lower their interest rates.  Two things happened, the crash of 1987 and television as a tool to deliver financial news.  I remember unplugging my television (CNBC) from my desk in early 2001.  If CNBC went off the air tomorrow I wouldn’t miss it at all.

When I saw the basic math for model price, just a kernel of what we have today – I saw the potential.  As the team built on these foundations I could start reconciling the movement of stock prices.  Stock prices were conforming to these valuations zones, now known to you as Economic Book Values (EBVs) or Economic Structural Values (ESVs).

We went into the bull market of 1998 – 2000 armed only with our EBVs.  What we were observing was something different.  There was a feedback mechanism-taking place that had to do with the structure of the balance sheet.  Curiosity. Hard work.  Convexity.  Model Price.

What is my dream?

I see it nightly.  There is a panel of experts.  CFAs’, stock analysts’, true experts in the field of equity securities analysis.  Sure, include a technical analyst for good measure. All gathered to opine on some equity security. Telling investors in their own way, they haven’t a clue what the security is worth and where the equity price is heading.

The panel is facing a six year old with an iPad.  The six year old calls up Facebook, starts up the Model Price application and drops in the symbol that is being discussed.  Presto, the child can recite what the stock is worth, model price, and with a blink of an eye can tell the audience, specifically, whether fundamentals are improving (equity price breaking up through EBVs) or declining (equity price breaking down through EBVs).  The six year old can give support and resistance price targets that work over time, much to the amazement of our esteemed panel of experts.

The financial industry, and finance itself needs a total rework in my estimation.  I have made this app, the graphical interface, as simple as possible.  Yes, the explanations maybe difficult to grasp but I have time and hopefully through this blog these concepts will become familiar to you.

I don’t care whether the financial professionals get it!  I care about the six year olds.  I care about the people finance has locked out.  Finance should be for everyone.  It’s time for democratization – finance’s Arab Spring!

Yes, I have been a registered securities broker for 26 years.  Started with the question, ‘Why do stocks go up and down?’ for close to 40 years.  I have not seen any security analysis anywhere that comes close to what I’m delivering here and Facebook.  No catch.  It’s the best I’ve found and developed with the help of others.  We are not going away.

Why do stocks go up and down?

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