Category Archives: Level II

March 2015, S&P/TSX Composite Market Strategy Update

Every time I look at our model price chart of the S&P/TSX Composite Index I see a visual. What is that visual picture you ask?

Well, first let’s look at the model price chart of the aforementioned Canadian index.

S&P/TSX Composite Index with weekly price bars and EBV Lines.

S&P/TSX Composite Index with weekly price bars and EBV Lines.

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

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 equity 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.

This is the visual I have in mind…

Hanging in there!

Hanging in there!

The Canadian market like this poor little kitten is trying to hang in there. Trying to hold on to EBV+2. Yes, this Canadian market index trades a little above and below this EBV line and has yet to make up its mind where it wants to go.

And this stalemate – between the buyers and the sellers – may last for sometime into the future.

The risk is the S&P/TSX Composite Index falls to EBV+1 or over 16 percent from the March 6th close that I have annotated on the above model price chart.

The other question that should be asked: Can the Canadian market have the strength to rally up to EBV+3 or 20,571 (approx. 38% from the March 6th close). Maybe! Though I think the probability would be low but must be considered. As we all know kittens have a habit of defying gravity sometimes. If the most bullish scenario occurs in the U.S. equity markets (see my March blog post on the S&P 500) then the Canadian equity markets would certainly follow the U.S. lead in terms of expanding equity valuations.

So we wait.

The Canadian market is at support with one of our structural EBV lines, and that makes sense, and it’s waiting. So we have to be patient as well.

Not earth shattering analysis, but sometimes boring is good.

March 2015 – Monthly S&P 500 Market Strategy Update

When the global central banks want asset values to go up…. They go up!

As I noted in my last blog, we have seen unprecedented central bank activity so far in 2015 resulting in – no surprise – higher asset (equity) values especially in the United States.

Can asset prices go up forever? Or better still can confidence in the men and women who control central bank activities go any higher when everyone in the investment community is already giving them a standing ovation?

Let’s have a look at our Model Price chart to look for clues on how far asset pricing can go.

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.

As you can observe the US market, as defined by the S&P 500, is now at the top of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2175) this would represent a gain of some 2.7%. If the market corrected back to EBV+3 (1739) investors would be suffering losses of almost 18%.

For people new to Model Price Theory [MPT] the index value or equity price can move within an EBV zone with no real consequence. However when a transit occurs – index value or equity price crosses one of our parallel lines – our EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.

 

Top of Zone EBV+4

 

I believe it’s fair to say we are finally at the top of the zone (EBV+4). Viewing the market this way, call it my first iteration; this is what I believe is the “top” in the U.S. market – valuation wise.

Long time readers of this blog have seen our long-term model price chart on the S&P 500 Index a few times previously but I include it below to illustrate that even if I view EBV+4 as the “top” of the S&P 500 Index in terms of valuation the market can crawl along just underneath our calculated EBV line for a number of years as the market index did from 2003 to 2007.

Long-term Model Price chart of the S&P 500.

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

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

 

Sharp-eyed observers will notice that our EBV+4 line (black line between the ‘Red’ line and ‘Yellow’ EBV line) continues on after the last price bar as of March 2, 2015. We project out our estimation of our EBV line by calculating from a bottom up basis or company-by-company basis adding daily pro-rated mean estimates to each company’s net worth less stated dividends and calculate (forecast, if you will) what our EBV values will look like. We do this on a daily basis to incorporate all the latest changes in company fundamentals within each index.

Our calculation of EBV+4, for March of 2016, is 2378. From the March 2, 2015 close (2117) this suggests an implied rate of return of 12% just on the growth of book values (net of dividends, of course) in the S&P 500 Index. Add in a further 2% for dividends and an investor can guesstimate an implied upside for U.S. equities of 14% without any increase in valuation if things go swimmingly.

But one has to ask the most obvious of questions.

Could the S&P 500 have a positive transit of EBV+4?

This is the second iteration an investor has to consider. Again, as sharp-eyed readers can observe back in 1995, the S&P 500 Index was following along the same EBV+4, when it lifted-off and the index ran up to EBV+5 in 1997. As a matter of fact, as you can see from our long-term model price chart, the S&P 500 index almost made it to our calculated EBV+6, calculated back in the day!

The question has to be asked: Was the economic scenarios or environment different in the 1995-2000 period from the 2002-2007 period?

The answer is a resounding yes!

What was the difference?

The U.S. dollar!

Below is a long-term chart of the U.S. Dollar Index (DXY) from Bloomberg.

U.S. Dollar Index (DXY)

U.S. Dollar Index (DXY)

 

I have annotated on this chart the various Bull/Bear market cycles of the U.S. Dollar (DXY Index) coinciding with each U.S. President.

Hopefully, you can clearly see the difference between the two equity bull markets of 1995-2000 and 2002-2007 periods. The first, 1995-2000 equity bull market, occurred while the U.S. dollar was also in a bull period, while the second, 2002-2007 equity bull market occurred while the U.S. Dollar Index was going down or in a bear market.

I have been on record, certainly on BNN and other media outlets, that I believe the fundamentals are in place that we can see a value on the U.S. Dollar Index that would rival the Ronald Reagan Bull Market of the U.S. Dollar Index at over 160. (Maybe this is a little optimistic but certainly Clinton’s Bull Market rally to over 120 would certainly work in my analysis.)

When global money flows pour into the U.S. Dollar, as momentum is starting to pick up since December 2014, global investors will look for U.S. dollar dominated assets to park their cash. Yes, the U.S. Treasury market is an obvious choice but certainly some money flows will seek out the S&P 500 Index ETFs for diversification and maybe a little extra return…. not to mention a 2% dividend yield that rivals current 10-year U.S. Treasury yields.

Is the analysis too simple? Sometimes simple is best!

And yes, fundamentals do count… eventually over secular periods of time, however in my experience money flows usually trump fundamentals over the short-term.

What Am I Saying?

Readers have to consider that conditions are in place that a positive transit of EBV+4 is indeed possible and if money flows get out of hand or momentum is too strong EBV+5 could indeed be possible.

The risk here is that the investment community is way too bearish and conditions are in place that the U.S. equity markets have another EBV zone to go, in terms of valuation, to the upside.

Model Price Theory has the timing problem solved!

You hear and read this all the time on various websites, especially on bearish or perm-a-bear forecasts. Yes, the world is coming to an end because of all these very logical reasons however they can’t tell you ‘When’ this will happen.

O.K. you will face financial ruin…. but we can’t tell you when.

Model Price Theory [MPT] to the rescue!

How does MPT solve the timing issue you ask? Easy, wait for any negative transit of one of our EBV lines. Will this negative transit occur at EBV+4, EBV+5 or EBV+3? I haven’t a clue…but I will know it when I see it.

Doesn’t this solve the timing problem?

I believe so. So on a negative transit, any negative transit – which I will probably blog about – somewhere out there in the future, we will turn cautious on U.S. equities.

Again, my critics may scream “too simplistic.”

I don’t know about you but I do like “simple.”

Conclusion

The S&P 500 Index is now at the top of our EBV zone between EBV+3 and EBV+4. I have speculated or hypothesized on two iterations where the S&P 500 Index either crawls along just under EBV+4 until fundamentals or money flows start to turn negative – that could be years down the road – or the S&P 500 Index has a positive transit of EBV+4 and may have enough momentum to carry the index all the way to EBV+5.

Do I know for certain which scenario will occur? No, I don’t.

But I am certain any negative transit will give me the opportunity to adjust my asset allocation to a more cautious stance if and when this aforementioned negative transit has indeed occurred. And I will be ready for the widely believed financial calamity everyone seems to be forecasting.

 

 

P.S. I would be remiss not in acknowledging the anniversary of the bottom on the S&P 500 Index six years ago – on March 9, 2009 to be exact – at an index level of 666.

Not to be overly overt but I have included a screen shot of the front page of our Acker Finley website giving the performance relative to our benchmark (S&P 500 Total Return Index in CDN$) of our Acker Finley US Value 50 Fund priced in CDN dollars. Yes, we are up over 350% from March 3, 2009 to present, after all fund expenses.

Acker Finley Select US Value 50 Fund performance over the last six years. March 3, 2009 - March 4, 2015

Acker Finley Select US Value 50 Fund performance over the last six years. March 3, 2009 – March 4, 2015

 

I will never forget this bottom for as long as I live and it hardly seems possible that this event occurred six years ago – feels like yesterday.

A substantial part of this return occurred because we were fully invested at the market bottom on March 9, 2009.

For those interested, I blogged what I did differently in the market crash of 2008 that I didn’t do in my previous experienced market crashes of 1987 and 2000 on the fifth anniversary of the market bottom obviously one year ago. Of all my blogs this one remains one of the most popular.

“10 Things I Did Differently in the Crash of 2008; That I Didn’t Do in 1987 and 2000.”

 

Central Bank Maneuvers

Is 2015 going to be the year of central bank fireworks?

On Thursday morning the Swiss National Bank (SNB), Switzerland’s central bank, shocked everyone by eliminating the floor on the Swiss franc and will start charging a negative interest rate (0.75%) to anyone holding their national currency.

In response the Swiss franc exploded upward, up almost 30% against the euro and other global currencies. This move was one of the biggest currency shocks since the collapse of the Bretton Woods system in 1971, as many financial columnists have pointed out.

So let me be clear…. if I had $1 million Swiss francs on deposit at a Swiss bank, the bank is now charging me $7,500 francs per annum for the pleasure of holding these Swiss francs. The result? Individual and global institutions lining up Thursday to purchase Swiss francs!

Huh?

Global finance has gotten a little crazy these days, don’t you think?

The other little thing – tongue in cheek – that is going on is nominal interest rates on any and all government debt has been falling like a stone over the past year. Except for Greek government debt, and who knows whether a bondholder will eventually get paid back in Greek euros or drachmas, all sovereign bonds yields have had a big move in price (upward) and yield (downward). Shouldn’t interest rates be going up by now?

I have to say these bond moves (big moves by historical standards) have become the 800-pound gorilla in the room of all portfolio managers and investment strategists. Nobody, it seems can explain it (lower yields) but better still nobody can say where the yields are going and certainly nobody wants to extrapolate what this means for the global economy.

So what is the end game here, I continually ask myself… in terms of global bond yields?

And let me go further to posit the question: Will nominal yields on all sovereigns go to zero? (Germany, Japan and a few other European countries have negative interest rates on their government bonds – up to 5 year and less – why not Canada?)

Here is screen shot of one of my favorite screens from the Bloomberg website showing 10-year yields of the major countries in the world and how much the yields have fallen during the year.

Screen Shot of Bloomberg Website Page

Screen Shot of Bloomberg Website Page

 

As Paul Krugman writes in his column, “Francs, Fear and Folly,” in the New York Times, “What you need to understand is that all the usual rules of economic policy changed when financial crisis struck in 2008; we entered a looking-glass world, and we still haven’t emerged.”

Can Model Price Theory explain what is going on here?

Partially.

First I want to show you two charts. The first graph I tweeted out back in November 2014 showing the global total debt (excluding the financial sector) for advanced economies plus major emerging market economies. As you can see debt has been growing at healthy rate over the last 12 years. Of course most of this increased debt is national and territorial governments issuing large amounts of debt to supplement increased economic activity.

Global debt to GDP

Global debt to GDP

The second chart is our Solvency Curve that I introduced to you back at the start of this blog and one of our ‘Key Concepts’.

Solvency Curve from Model Price Theory - See Key Concepts

Solvency Curve from Model Price Theory – See Key Concepts

 

It’s the dynamic of what the economic actors are doing along our ‘Solvency Curve’ in each national country over a period of time is what I’m pointing out here. First, each national government, since the financial crisis of 2008, has substantially increased their national debt – some larger than others. This Keynesian national debt increase helped individual and together globally national economies sustain and increase economic growth to correct substantial drops in global demand that occurred around the world because of the financial crisis of 2008.

As government debt increased, all national governments moved down our ‘Solvency Curve’ – left side – to a more insolvent state. All the other economic actors in each society see this, individuals and corporations, etc., and increase their own solvency to brace for future of tax increases (to repay the national debt accumulated) and reduced capital investment plans or projects to conserve cash as future growth looks uncertain.

For example, in Japan where the government has tried to lift the country out of its economic malaise and deflation, after its own financial crisis, for over the last 25 years has spent enormous amounts annually (budget deficits) to increase nominal demand and has increased the national debt to a staggering 229% of GDP – the largest of any country in the world today. Unbelievably, as the national government debt has risen, total cash held by individuals and corporations have also grown to a staggering 44% of GDP. Hope you see the dynamic going on here. The national governments going one-way (down our ‘Solvency Curve’ and everybody else is shifting (becoming Super-Solvent) to the right of our curve in response.

I know and would like to emphasize our concept – Solvency Curve – and movement along our ‘Curve’ is not the cause (not fully) of our current interest conundrum. It’s just until world governments and their respective central banks slow down this cycle or movement along the curve – each side of the curve moving away from each other – that lack of global growth and dis-inflation bordering on deflation is going to continue to occur.

Resulting in ever lower interest rates.

When and if these ‘Solvency Curve’ trends start to slow down or better still reverse (having national governments become more solvent allowing individuals and corporations to spend their cash and move up the right-hand side of the ‘curve’) do interest rates have the slightest chance of moving upwards.

Or is something going on here that is more prophetic with regards to interest rates.

Sometimes when I view this Bloomberg 10-year government webpage I feel it’s more like a countdown. I’m I witnessing a secular fall in interest rates that will last for a generation? Will global long-term interest rates in the western world and Europe go to Japanese levels and perhaps stay there, again, for a generation? What happens to western society, business investment and retirement plans if and when we have low interest rates for a prolonged period of time? Do these questions make any sense? Am I scarring you?

How are we in the west, the developed nations, supposed to retire if interest rates go to zero? Want to earn $100,000 in interest income? Well, at the current interest rate of 1.53%, a Canadian resident currently needs $6.5 million invested in a 10-year Government of Canada bond. Who has this amount of loose change lying around to retire on? But, I guess, the good news is that interest rates are 1.5%! What happens if they go to zero?

Just asking.

 

 

 

 

January 2015, S&P/TSX Composite Market Strategy Update

 

Is the tide coming in or out?

Don’t get this reference? Please refer to my previous blog “January 2015, S&P 500 Market Strategy Update” for a refresher.

The tide is certainly going out in Canada. World money flows have reversed not only in the commodity countries (Australia and Canada) but also in the BRIC countries, as well.

Commodity prices are slumping, with a huge drop in oil prices leading the way. Actually it’s kind of fun watching people in the financial press spin themselves into circles trying to come up with a reasonable explanation as to what is depressing crude and other prices.

I have no clue as to what is going on here – I can guess like others – but it seems to me both on the supply and demand side of the equation market dynamics and complexities are being sorted out by a daily market price that we all can see. So leave the predictions to others, here at Model Price, we have no need to entertain worthless prognostications when dealing with real facts.

See here at Model Price we have two pieces of independent data coming together and giving you real information – investible and tradable information. What are these two pieces of information? Stock prices (index values) and our calculated EBV Lines! Each source and piece of information is both independent and verifiable. I don’t know of any other financial concept or tool in use today that even comes close to this very valuable tool. And to me, even though it looks like technical analysis, this information gives me clues and a heads up on future fundamentals of a company and the market. Sure, we will never know in real time what the public future news will be, but as we all know markets always seem to move before the fact.

What is the Canadian market saying through Model Price?

First, let’s have a look at the model price chart of the S&P/TSX Composite Index as of January 12th, 2015

S&P/TSX Composite Index with weekly price bars and EBV Lines.

S&P/TSX Composite Index with weekly price bars and EBV Lines.

 

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

As you can observe the Canadian market, as defined by the S&P/TSX Composite, is in the zone bookmarked by EBV+1 and EBV+2. If the market rallied to EBV+2 (14,764) this would represent a gain of some 3.5% (Upside). If the market corrected back to EBV+1 (12,405) investors would be suffering Index losses of almost 14% (Downside).

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, respectfully.

As I have annotated on the above model price chart we have experienced three negative transits starting back in mid-September. What does this mean? Simply the fundamentals are deteriorating in Canada and the market will probably feel more comfortable trading in the valuation zone between EBV+1 and EBV+2. Yes, this means EBV+2 now becomes resistance and EBV+1 becomes support. And, support for this market is a long way down…some 13%!

As I have said in last month’s blog on the Canadian market;

Where are we going, in terms of the Canadian equity market? Not sure! But until we see positive transits both in individual stocks and the S&P/TSX Composite Index I would be cautious with a healthy cash balance and wait and see where this market wants to go. I’m reminded of the great quote by Yogi Berra, “It’s tough to make predictions, especially about the future.” A negative transit is a negative transit and an investor can act accordingly, the future can take care of itself with or without my and your capital.

Conclusion

Three times the market has spoken. This is rare that a market through an index or a stock gives anyone this much of a warning. But in this situation the Canadian index is certainly giving all Canadian investors a warning that negative fundamentals maybe on the horizon. Certainly investors in the Canadian oil patch have already experienced negative (maybe severely negative) rates of return.

Any stock in the Canadian equity markets that resides in your portfolio and has a negative transit would be a sell candidate in my mind. Bear markets are about survivability on one hand and opportunity for excessive trading profits when to dust and the falling stock prices have stopped. This spells great opportunities ahead in the Canadian equity markets for those with capital and superior leading information about changing market fundamentals – future positive transits.

I can’t wait!

January 2015, S&P 500 Market Strategy Update

Sometimes simple is best.

Over the Christmas holidays I overloaded on financial business news. How do I know I was overloaded? I got confused. Like a pilot flying by the horizon on a cloudy day and not by his/her instruments, I was off course and started to stall.

Do you get like this sometimes especially about the financial markets? You want to take everything in. You want to hear from all the so-called experts and go through their PowerPoint decks. But at the end of the day…. what are you left with? What information should you weigh more than others? Speaking for myself I simply get confused and locked in a world where doing nothing, or worse, thinking I should go to cash is the result even though I know it’s not the optimal course of action.

Then I return to my world of MPT [Model Price Theory] and everything starts to make sense to me. All stock prices and index values look logical and rational. And a simple aphorism usually leaps out of nowhere from my subconscious that guides me on the right course. And in this instance it came to me in the form of a question.

“Is the tide coming in or out?”

Yes, I know I’m from the east coast – where tides rise and fall 35 to 38 feet, 40 minutes from where I grew up – but I think this simple question will help you distill all the financial analysis that is currently out there.

Huh?

If you have seen me on television you know I’m a big fan of the US dollar. (If not see my blog here on ‘King US Dollar Returning’.) So what does a strong US dollar have to do with anything? Well if the world is purchasing US dollars they need to purchase something with these dollars…yes? A lot of these dollars usually end up in the bond market, US Treasuries as a matter of fact. However some of these dollars do end up in the equity markets. And like the US Treasuries the instrument of choice for most foreigners is the S&P 500 Index ETF or what is known as ‘Spiders’.

Also big moves in currencies usually take a while to occur, that I like to call ‘secular’. How long is ‘secular’? Probably five (5) years a least. So as the US dollar floats upward this usually begets more buying further increasing the value of the dollar.

So, is the tide (in the value of the US dollar) coming in (up) or out (down)?

The tide is certainly coming in! And will do so for a ‘secular’ period of time. What will that do to US assets as a whole? US assets will go up, again over time.

How simple is that? “Pretty, pretty simple!” as Larry David would say.

And I like simple.

You?

As usual in these monthly blogs, let’s have a look at our Model Price chart on the S&P 500 Index to see what is going on.

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

S&P 500 Index with weekly price bars andEBV 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 (2217) this would represent a gain of some 8.2%. If the market corrected back to EBV+3 (1773) investors would be suffering losses of almost 14%.

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, respectfully.

Having another look at our long-term model price chart of the S&P 500 Index.

I haven’t published our long-term model price chart for a while, so let’s have a look.

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

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

 

As you can appreciate this long-term chart highlighting monthly price bars doesn’t change very often however I find this chart interesting to look at every once and a while.

What I like to draw your attention to are points ‘A’ and ‘B’ that I have annotated on the above chart. Roughly between 2002 and 2007, 5 years, the S&P 500 Index travelled along EBV+4, finding price support and resistance, along our calculated EBV Line.

Could this happen again?

Absolutely! Investors should consider all possibilities and probable market outcomes including the possibly of the slow upward gird. Less thrilling and won’t sell financial news impressions (‘clicks’) or link-bait but very profitable for investors who are long equities.

Is EBV+4 exceedingly expensive in terms of valuation?

Not really! Certainly the S&P 500 Index travelled this path before with higher interest rates and the US in the middle of raging two very unpopular wars – viewed in hindsight.

Were there scary moments over those 5 years – between 2002 and 2007 – that investors worried about holding equities? Again, I’m sure there were but the market still barreled forward in terms of gains, matching the compounding of book value of companies, included in the S&P 500, but not increasing the valuation of the overall market.

During this time period 2002 and 2007 the US dollar was in general moribund. The ‘action’ or money flows was directed to commodity countries (Canada and Australia) and of course the BRICs. Currently, with positive US dollar fundamentals this ‘tide’ will lift all boats, if you will. Economic fundamentals will count, of course, but money flows will help companies not only maintain valuations but also help during periods of economic and industrial rotations and/or dislocations. In other words, market corrections should be shallower and brief.

Conclusion

I don’t know if it’s me but the financial stuff I’m reading on the Internet is unusually bearish. And as I preface this blog even I get bogged down in the negativism that seems to be everywhere. But don’t be fooled, money flows into the US dollar are now positive – the tide is coming in! This very important and infrequent occurrence will help support the market’s valuation and may help increase valuations, maybe to EBV+5, as our global economic issues dissipate as national governments and central bankers adjust to new economic realities.

There are now millions of financial websites and I’m guessing here but most seem to be negative in orientation. Everyone viewing these sites on a regular basis can get caught up in their own ‘echo chamber’ of regular and recurring negative news even in good equity markets!

For me, this endless series of bad news and market factoids not only clutters up my thought process and at worst a major time waster. But sometimes, like over Christmas vacation, one does, and I did, take a peek to see what’s out there – guilty, your honor! Thank goodness for MPT [Model Price Theory]. At least I (and you) can run back to a world we have created that valuation of equities make rational and economic sense.

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

Everything you learn and read about financial markets seems so wishy-washy (call it subjective).

I’m a black and white sort-a-guy (and an accountant) and when it comes to dollars and cents my question has always been can’t the field of finance be more…. objective?

If you’re like myself…and why wouldn’t you be… then Model Price Theory [MTP] is made for you.

Welcome to the world of black and white!

And speaking of black and white, Canadian equities are in a BEAR market and that’s not being wishy-washy, it’s OBJECTIVE!

The last BEAR market in Canada was in 2007-08, and man, it was a doozy! I will be sporting those market scars for sometime. (See my blog “10 Things I Did in the Crash of 2008; That I Didn’t Do in 1987 and 2000”) However before I go into what a BEAR markets means for investors let’s review what transpired, in terms of market action, since my last blog (November 6, 2014) on the S&P/TSX Composite.

As a reminder here is the model price chart I included on my November 6th blog.

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).

I stated in this blog:

The first negative transit is usually the market testing or whether the index belongs in a lower zone, in this case between EBV+1 and EBV+2. Again, in general, the market (I’m talking about indices here) usually rallies above the EBV Line it just negatively transited.

And sometime later – could be months/quarters another negative transit will occur confirming the initial negative transit.

THIS SECOND NEGATIVE TRANSIT WOULD CONFIRM THAT THE CANADIAN MARKET HAS ENTERED INTO A BEAR MARKET.

Well, guess what…. we had a second negative transit!

Here’s a current view 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).

 

And it was a sneaky negative transit that occurred on December 4, 2014, which was a Thursday. I notified members of the Model Price community on Facebook through the following comment:

From the 'Comments Section' from the Model Price app on Facebook

From the ‘Comments Section’ from the Model Price app on Facebook

 

Friday, December 5, 2014 was also an interesting day that looked peaceful on the surface but according to Model Price Theory [MPT] the Canadian market through the S&P/TSX Composite Index communicated to those willing to listen. I wrote the following comment on Facebook:

From the 'Comments Section' from the Model Price app on Facebook

From the ‘Comments Section’ from the Model Price app on Facebook

And the following week, the week of December 8th to the 12th, the S&P/TSX Composite was down in round percentage numbers 4.5% (see model price chart above).

What This Means To You as Investors

Gravity will have an impact on all asset values (share prices) in Canada even top quality or respected big corporate names we can all list off the top of our heads. For those who know Model Price Theory [MPT] selling stocks that have a negative transit is a must, even those respected corporate names we all know. Investors must be vigilant about all Canadian shares to ensure loss of capital is kept to a minimum.

Where are we going, in terms of the Canadian equity market? Not sure! But until we see positive transits both in individual stocks and the S&P/TSX Composite Index I would be cautious with a healthy cash balance and wait and see where this market wants to go. I’m reminded of the great quote by Yogi Berra, “It’s tough to make predictions, especially about the future.” A negative transit is a negative transit meaning an investor should act accordingly, the future can take care of itself with or without my (and your) capital.

Conclusion

Model Price Theory [MPT] is giving you ‘objective’ information. ‘Black and White’ info that only an accountant would love. Yes, we are in a BEAR market in Canada but that’s not the end of the world. As I have said in previous blogs, you can make money in a BEAR market, it’s just you have to redouble your energy, efforts and your discipline if you choose to participate.

When I come to the office everyday, my first question of the day is: “What market are we in”? Up until last Thursday, December 4th, the answer was always “We are in a Bull market”! Now that answer has changed and I’m judging myself accordingly.

Hope you are as well.

Teck Cominco Goes “Into The Blue”!

 

NEWS FLASH – NOVEMBER 10, 2014 CITIGROUP CUTS 2015 IRON ORE PRICE EST. TO $65/TON VS $80/TON, SAYS IRON ORE PRICES MAY FALL BELOW $60/TON.

 

Welcome to the new world of decreasing commodity prices.

The business media still hasn’t got their arms around this story. And it’s a big story.

China added 5.9 billion square meters of commercial buildings between 2008 and 2012 – the equivalent of more than 50 Manhattans – in just five years and that’s a lot of steel/copper!

What do you think is happening in China now?

Are they going to build another 50 Manhattans…probably not is my guess.

Iron ore prices started around $16 per dry metric ton in 2004 and spiked to almost $200 a ton in October 2010 and now it’s on the way down as you can read from this tweet from Twitter.

This shouldn’t be any surprise to the Model Price user. There have been many negative transits of Teck Cominco since peaking in price in early 2011 and finally falling into the “Blue” – going below EBV-3 – some six weeks ago and one of our strongest sell signals. See Model Price chart below.

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

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

 

Now if Teck Cominco was trading at over $60 per share in early 2011 and is now trading for less than $18 today, one would think that most of the pain would be over for shareholders. And you can probably see the value orientated money managers rubbing their hands in glee. Teck now trades at about 45% of accounting book value and pays a generous 5% dividend yield.

As a matter of fact while enroute to the office kitchen last week, I overheard on the trading room television – which is always tuned into BNN – a portfolio manager recommending Teck Cominco to viewers with the usual comments…. “Great management, great assets and of course, a nice dividend”!

Really!

What Model Price Theory [MPT] is saying?

When the stock price of a public company drops below EBV-3 this signifies that balance sheet write-offs of recorded asset values will be coming sometime in the future. And when the company starts to write-off recorded assets, debtholders start to get nervous. And, you guessed it, when debtholders get nervous the dividend payout to the common shareholders will be cut if not eliminated.

In essence Teck Cominco can and probably will be a ‘value trap’ in that, yes, the company looks like it has good value, a high discount to accounting book value, and a high dividend only to potentially disappear before your very eyes.

And, yes I have noticed that our model price is calculated at $26 this year and over $40 in 2015. But this is based on equity analysts’ earnings estimates today. Will these estimates be impacted by Citigroup’s lowered forecast estimates for Iron Ore? Has the declining spot price of Iron Ore fully reflected in the estimates we are currently using? And has the declining price of Iron Ore been so precipitous that equity analysts have been frozen and have not updated Teck’s earnings waiting for some sort of stabilization in the pricing of the commodity so any earnings estimate – guesstimate – can be realistic.

Of the two pieces of information – model price value or EBV Lines – my preference is always tilted towards our EBV Lines especially in down markets. Why? It’s what the market is communicating that has more value to Model Price users than what the analysts are saying.

Most Cyclical Stocks Are Pro-Cyclical

What do I mean by this….pro-cyclical? Cyclical companies balance sheets also seem to explode in the dollar amount of net equity or net worth as a consequence of peak cyclical earnings and intra-industry acquisitions. Have a look at our long-term model price chart of Teck Cominco’s. Notice how the balance sheet of the company has grown since 2004 – upward sloping EBV Lines mirroring the growth of Teck’s balance sheet (below). Hmm…. Can this balance sheet growth be a coincidence with the price of Iron Ore? This is what I mean by pro-cyclical in that, in this case, as the price of the commodity – Iron Ore – escalates so does the balance sheet of the company.

Teck Cominco's Long-term Model Price chart from 1995 to Present

Teck Cominco’s Long-term Model Price chart from 1995 to Present

As commodity prices recede or reset, to much lower prices, the company is forced to write-off excess assets that are non-productive or non-economic relative to the cost of production versus the falling price of the commodity in question.

As the write-offs occur over a period of time or the ‘big bath’ write-off is taken – usually by new management not accountable for past investment decisions – the size of the pro-cyclical company’s balance sheet reverts back to lows seen at the bottom of previous cyclical lows. And cyclical lows for Teck’s balance sheet is a long way down as you can see.

Conclusion

So don’t be fooled. Yes, Teck Cominco seems cheap. Yes, the company is paying out a healthy dividend. And, yes, our model price calculation is above where Teck’s currently trading at what appears to be a 43% upside. But our model price calculation is only as good as the group of analysts with their earnings estimates and nobody I know has a crystal ball or better still knows what is going on in China.

The very important “tell” here is the share price of Teck going below our EBV-3 or as we say in our office ‘Going into the Blue’. This is very important information alerting investors that serious balance sheet realignment (write-offs) will be coming.

Yes, you can see the future in this situation and the counter-cyclical forces will play havoc on investors who think they are purchasing Teck’s recorded assets at 55 cents on the dollar and a dividend stream – yes, getting paid to wait (cough!) – that may not last beyond a few quarters!

 

 

 

 

 

 

 

 

 

 

 

 

‘King’ U.S. Dollar Returning!

If you listen carefully the groundwater beneath the global financial markets is beginning to shift. And you should be paying attention.

I’m talking about the U.S. dollar. After more than a decade in the doldrums global financial flows are beginning to find its’ way into the greenback and the financial press have noticed this in the last few weeks.

I believe these global funds flow into the U.S. dollar is a secular (long-term) decade long financial phenomena that will have large impacts on investors’ rates of return for years to come.

And most equity investors have no idea that currency trends have big impacts on potential future gains/losses. Hell, do you know what the academic community says about shifting currency trends. Ignore it! They repeat this mantra like a skipping vinyl record, if anybody knows what this means anymore, that currency movements over the long-term have no impact on equity investment returns.

Really!

I especially focus on the U.S. – Canadian dollar exchange rate – no surprise here – because the majority of our clients at Acker Finley spend Canadian dollars at the end of the day including myself. Getting this exchange rate right is critical to preserving any sort of purchasing power for spending time, whether retirement or vacation time, in the Unites States where the majority of Canadian folks want to spend their leisure time.

I’m also interested in accruing larger rates of return in Canadian dollars from equity asset allocations with little to no added potential risk. And by getting this secular trend correct, the U.S./CDN exchange rate trend, I can easily accomplish this.

Want an example?

To howls of laughter, back in 2001-02, when the Canadian dollar was selling at $0.65 – $0.68 to the U.S. dollar, I predicted the Canadian dollar would eventually be selling at par to the U.S. dollar. I had lunch roundtables at our offices at Acker Finley, made predictions on BNN and made sure all Acker Finley clients didn’t have U.S. dominated assets held in their accounts. (When we started our Acker Finley Select US Value 50 fund in November 2003, we made sure the fund’s assets in U.S. securities were hedged – one of only a handful of foreign mutual funds at the time – so that a rising Canadian dollar wouldn’t reduce the fund’s performance over the long-term. Looking back this decision to hedge our U.S. portfolio materially boosted Canadian dollar returns over the last ten or so years.)

I have changed my opinion on the U.S./CDN exchange rate ….two years ago!

Yes, I have now changed my opinion on the U.S. dollar, actually two years ago, and this decision can be traced to the elimination of the currency hedge we instituted in the aforementioned Acker Finley Select US Value 50 mutual fund. We substantially eliminated all our Canadian dollar forwards on our U.S. portfolio of equities in June of 2012 at $1.0217 cents U.S.

Yes, I bought Canadian dollars at $0.68 cents some ten years ago and sold them at $1.0217 a couple of years ago, not a bad trade! Of course the academic community says ‘in theory’ nobody can do this successfully – trade an undervalued currency for an overvalued one – but to me it’s obvious and I’m doing what I feel my clients are paying me to do even though it may not be obvious to their overall rates of return as purchasing an individual bond or stock!)

Why mention this?

Review all great U.S. ‘Bull’ markets of equities in the past 30 years and they coincided with a bull market in the U.S. dollar. As global funds flow moves into the greenback these now U.S. dollar funds start to look for rates of return. The most convenient risk free instruments are usually U.S. Treasuries but for risk assets the instrument of choice will probably be the S&P 500 Index ETF or ‘Spiders’, as it was in the late 1990’s.

Yes, it’s just that easy. A virtual and prosperous two-step cycle will occur as global funds flow converted into U.S. dollars will positively impact the value of the U.S. dollar against other major currencies (US Dollar Index – see below). Followed by the second step of an allocation of U.S. dollar holdings by foreigners to large capitalized equities having past positive rates of return. Which begets more global funds flow.

Am I guessing here?

No, as with my Canadian dollar call back in 2002, I’m using Model Price Theory [MPT] as the basis for my call. All national governments have balance sheets like public companies that form a basis for our model price calculations that you see in our Facebook application. Back in 1995 the Canadian federal government set us on a road of improved balance sheet solvency by cutting back on federal spending and deficits. The model price math was obvious and my call on the Canadian dollar was equally as obvious by-product of the math. The exciting part is the U.S. federal government’s balance sheet is starting to look at lot better than two years ago (deficits are coming down) and the model price math is pointing to increased solvency, much in the same way as Canada’s federal balance sheet back a decade ago.

U.S. Dollar Index

Here is a chart of the U.S. Dollar Index reproduced from the Wall Street Journal.

Notice this chart goes all the way back to 1997 and shows a weak U.S. dollar relative to a basket of currencies that make up this index.

Source: Wall Street Journal

Source: Wall Street Journal

I know I keep on repeating this often but I’m no Technical Analyst (TA) however I like what I see here. I do like to look for market bottoms especially bottoms that occur over long periods of time and I do believe this U.S. Dollar Index qualifies.

Yes, we are finally witnessing the U.S. dollar is starting to gain in strength after a decade of being the red headed stepchild compared to most of the world’s currencies. Just a couple of years ago financial experts were predicting the end of the U.S. dollar’s world reserve currency status when we, Acker Finley, was buying U.S. dollars on any sign of weakness.

If this U.S. Dollar Index breaks above 90, as illustrated, I believe a long-term rally will be confirmed to all trend followers and momentum investors alike driving U.S. dollar demand to US Dollar Index levels that we haven’t witnessed in over two decades (1982 to 1986 period).

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

Since it’s September and everyone is back to work or school, and I haven’t reviewed the Canadian market for a while, let’s have a look at our model price charts.

First, let’s have a look at the long-term model price chart of the S&P/TSX Composite Index to get some context of where we are and more importantly where we are going – probably.

 

Long-term Model Price Chart

 

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

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

 

As you can observe the S&P/TSX Composite is in the zone between EBV+2 and EBV+3. It doesn’t take a brain surgeon to figure out that this index will probably reach EBV+3 over a period of time especially if the US market reaches EBV+4. Again timing is difficult for us but at least we have a roadmap.

And like my comments on the S&P 500, I believe the most likely scenario will be for this Canadian index to rise to EBV+3 (Red Line) and then crawl along EBV+3 when the S&P/TSX Index finally achieves this EBV level – see illustrated on model price chart above.

Zeroing in to our short-term model price chart reveals the following

 

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

As you can observe the Canadian market, as defined by the S&P/TSX Composite, is in the middle of the zone bookmarked by EBV+2 and EBV+3. If the market rallied to EBV+3 (19,592) this would represent a gain of some 26%. If the market corrected back to EBV+2 (14189) investors would be suffering losses of almost 9%.

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.

So the question of the day is, “What industry sectors need to rally in order for the S&P/TSX Composite to rally up to EBV+3?”

When one looks at the S&P/TSX Composite Index three industry sectors make up 84% of the total Canadian composite index value. Financials make up a large 34.4%, with Energy 26.2% and Utilities/Telecoms 23.4% making up the balance (of the total 84%). So let’s do a quick review of each sector to get a sense what these three sectors need to do for the S&P/TSX Composite Index to achieve EBV+3.

Financials

Canadian financial stocks have been buoyant for much of 2014 as you can see from our long-term model price chart on the S&P/TSX Financial Sector.

S&P/TSX Financial Sector Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Financial Sector Index with monthly price bars and EBV Lines (colored lines)

 

But as you can observe from the above chart the overall sector valuation was substantially higher, over EBV+2, in 2007. Even in 1998 the Canadian financial sector peaked in valuation over EBV+1.

So a reasonable person can conclude that valuations in this sector could go higher, at least history does show higher past valuations.

Energy

Canadian energy stocks have had a good 2014, even though the sector has become stalled in the last month. This is logical because one can observe from the below S&P/TSX Energy Sector Model Price chart that the sector of energy companies has rallied just under EBV+3 and encountering resistance.

 

S&P/TSX Energy Sector Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Energy Sector Index with monthly price bars and EBV Lines (colored lines)

 

Looking at past valuations one can observe the positive transit of EBV+3 back in 2004, with the sector rallying to an eye popping EBV+5! One can also observe a positive transit of EBV+3 back in 1996 and rallying mid-way between EBV zones 4 and 5.

Clearly the Canadian energy sector does have room to rally and probably has to rally past EBV+3 to take the S&P/TSX Composite Index to EBV+3.

Telecoms

S&P/TSX Telecom Sector Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Telecom Sector Index with monthly price bars and EBV Lines (colored lines)

 

Hmm…. No surprise here.

Looking at the S&P/TSX Telecom sector we are at valuation highs going back to 1995. Some may point to 1998 to 2000 to say this index was at EBV+5 and higher. I discount this because Nortel was part of BCE at the time – remember – skewing both the valuation of BCE and our EBV valuation.

The bottom line here is the telecom index won’t provide much help in the S&P/TSX Composite index reaching EBV+3

Utilities

Now this was a surprise to me.

I thought ‘interest sensitives’ would be at the highest equity valuation since interest rates are currently at historic lows. But as you see on our S&P/TSX Utilities sector model price chart there is some headroom for the Utilities sector to reach EBV+3, as it did back in 2007.

 

S&P/TSX Utilities Sector Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Utilities Sector Index with monthly price bars and EBV Lines (colored lines)

 

You can also see back in 1998 this sector almost reached EBV+3.

Conclusion

Can the S&P/TSX Composite Index reach EBV+3?

Sure, there seems to be headroom, for valuation increases based on past years valuation highs, in the sectors that make up 84% of the Composite index that I have illustrated.

Can the S&P/TSX Composite Index reach this important valuation level, EBV+3, without the help of U.S. equity markets? No, of course not. But as the most watched S&P 500 Index pushes up to EBV+4 the less globally watched Canadian composite index will probably get pulled higher as well. This makes sense and jives with financial history.

Am I saying this is a slam-dunk that equity markets, on both sides of the North American border, will trade substantially higher in the near future and without risk? Of course not! But viewing valuation through the prism of our model price charts not only at the composite level but also at the individual sector level can give an investor an invaluable insight and a roadmap on a probable future valuation levels that equity markets can achieve based on the past valuation highs (and lows).

September 2014 – Monthly S&P 500 Market Strategy Update

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?

Confusing…. maybe?

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).

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).

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.

Conclusion

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.