There are no ‘Cheerleaders!’
If you want to put your finger on ‘what’s wrong’ with this market it’s that no one wants to cheerlead this thing. In the run up to the market crashes of 1987, 2000 and 2007 equities were the only game in town with the investment public along with institutional investors shaking pom-poms with excitement. Everyone back then, and I do mean everyone was invested with both feet with the financial press leading the charge.
Comparatively today as the S&P 500 Index hits all-time highs, on a daily basis, nobody seems to care. (See CNBC’s latest ratings courtesy of ZeroHedge here) Better still who or what group of people or institutions can be seen as leading the charge to invest in equities. Giving everybody the all-clear signal that it’s OK to be invested.
In the past bull markets we had Abby Joseph Cohen, George Soros and even Alan Greenspan for goodness sake! Industry leaders publicly announcing bullish price targets and trumpeting America’s inherit abilities and strength. Who and where are these people today? Anybody?
Or is having no ‘Cheerleaders’ the single biggest positive for the US equity market going forward?
And the institutions and retail investors who I talk to everyday – who are invested – seem to have the confidence only to have one foot in this market. It seems to me that for any reason if something were to happen – from a myriad of Global hot issues – or if a correction were to start tomorrow seemingly everyone would hit the sell button immediately.
Talk about ‘knife edged’ investing!
However look at our model price chart for the S&P 500 – below. It looks tranquil and upward sloping. Remember our index price bars show weekly movement of the S&P 500 and what does it indicate? Index price gains with no intra weekly price volatility.
In other words a perfect market to ‘Cheerlead’!
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.
As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2190) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1751) investors would be suffering losses of almost 13%.
For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.
Two Ways of Making Gains in the Market
Model Price charts can help investors differentiate between the two ways of making gains in the equity market. As the index price value increases and moves up in the zone between EBV levels, the valuation of the overall market is increasing. In other words the market, collective buyers and sellers at the margin are willing to pay more in price terms for the earnings generated by the companies included in the index or in this case the S&P 500. As the S&P 500 Index crawls to EBV+4 investors are benefiting from an ever-increasing valuation.
The second way of making gains is the growth of the book values of the companies included in the index. Companies over time usually increase their book value as excess earnings are accumulated on their balance sheet. We capture this growth by calculation of our EBV lines. If you observe upward sloping EBV Lines the collective companies in the S&P 500 Index are increasing their book value or net worth over time. Over long periods of time companies usually increase their book value after dividends are paid and stock buybacks are deducted from capital of about 4 or 5 percent compounded.
Why do I mention this?
Over the last soon to be six years, from the market bottom of March 9, 2009, investors have been benefiting from both increased valuation – from EBV+1 to over EBV+3 – and growth in book value of the underlying companies in the index. The past returns have been phenomenal to say the least…in the mid-twenty percent range compounded.
This however cannot last!
If you assume the S&P 500 Index goes to EBV+4 and stays there for a prolonged period – my most likely assumption like the period between 2002 to July 2007 (See long-term model price chart below) – the ever- increasing valuation portion of investors return will stop. Future stock returns will have to rely on the growth of the collective book value or the growth of our EBV Lines. So for instance, say the S&P 500 Index goes to the top of the zone or EBV+4 (2190). We calculate the value of EBV+4 in September 2015 to be 2420. This implies a return of 10.5% for the Index over the year. Which is good, don’t get me wrong, but not as good as the past 5 and a half years.
Long-term model price chart of the S&P 500 Index
S&P 500 Index with monthly price bars and EBV Lines (colored lines).
Am I adjusting everyone’s expectations… Yup!
Could there be other possibilities? Yes, countless including a market correction back to EBV+3, which is always a risk.
The great thing about Model Price Theory [MPT] are the ‘What if’ scenarios investors can see in a graphical format that makes mathematical sense. And from these ‘What if’ scenarios investors can position their portfolios to reflect market risk and reward.
US market gains over the last 5 years have been great. However, mathematically speaking, the US markets are running “out of headroom” and lower market returns are inevitable as ever increasing valuation is unlikely to continue.
This is not the end of the world. This is just a comment on the general index itself. For those who trade individual stocks – stock pickers – this future period of time, if my most likely scenario pans out, can represent a great opportunity to significantly outperform if you or your clients are comparing yourself to the S&P 500 Index as we did using MPT during 2002 to July 2007 period.
Yes, always a bright side when using Model Price Theory [MPT].
As always see what happens.