Category Archives: US Markets

January 2016 – Monthly S&P Market Strategy Update


Welcome to 2016!

And what a start it was. All negative of course, as you know.

In the first day of trading in 2016 the Chinese market sold off 7% and their regulators closed the market. And all this occurred before the opening bell on European and North American markets for 2016. China giving its version of Adele’s “Hello It’s Me” to the rest of the world.

And so everyone, globally, hitting the sell button for the rest of the week…save for Friday…giving us a day of rest not knowing what to expect in the following weeks.

Being in the financial business I hate and bored by the hundreds of financial predictions that will occur for the forward-looking calendar year. Back in the old days, when financial news was very hard to come by, predictions from ‘old sages’ (Bob Farrell and the like) seemed to have good value and laced ‘nuggets of gold’ giving myself a good reason to endure ink stained fingers for a day or two. Now I have to hear millennials giving predictions based on regressed data that has as much nutrients as a fast food meal.

The only prediction I can make is that the financials markets will be open this coming year and stuff will happen. And the market will telegraph whether the economic fundamentals will be improving or getting worst. Yes, that’s right. The market will tell you what’s going on…and it communicates through Model Price Theory [MPT] and all we; as users of MPT, have to do is observe. Prediction is easy however it occurs all year round and not just at the end of December/beginning of January.

The other observation I will make is we are entering the 7th year, marked by March 9, 2009 S&P 500 market bottom, of the financial crisis. Central banks, including the US Federal Reserve, have been experimenting with monetary policy trying to get the global economy back on track of pre-financial crisis global aggregate demand. The preferred policy tool of choice has been printing money or quantitative easing (QE). Asset prices have been boosted including equity valuations and real estate. And I have to admit this is a good thing. The business press is filled with what I call the ‘liguidationists’, who would like asset prices to fall to some 1930s level, so a very small minority, could benefit. This policy response would certainly skew income inequality even more than it is today.

As the US Federal Reserve increased interest rates in December, the market seemed to take this policy action in stride. The financial press and the man on the street was focused, of course, on the 25 basis points increase in Fed Funds. What they don’t see, and is critical, is the ‘reverse repro’ financial mechanism that was introduced at the same time. The New York Fed has been testing this financial instrument for the last two years. Not to get too technical but the Fed through this new instrument will start to drawdown the excess reserves sitting on the banks balance sheets. Estimates range from $3.5 to $2.5 trillion of excess reserves the Fed pumped into the banking system during the financial crisis, that the banks, collectively, have been sitting on and the Fed wants to take some of this back. Of course, they will start slowly at first, say $300 billion or so, but the important thing is the Fed is starting this process.

So over the last year or so, the US Federal Reserve has stopped QE and are in the process of withdrawing excess bank reserves. This is healthy and signs of the US economy returning to normal. Yes, good news…but you won’t hear this anywhere else.

So let’s look at our Model Price Chart of the S&P 500 Index.

sp500.n234

S&P 500 Index with weekly price bars and EBV Lines

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

As you can observe the US equity market, as defined by the S&P 500 closed Thursday, January 7th at 1943.06. If the market rallied to EBV+4 (2208) this would represent a gain of some 14%. If the market corrected back to EBV+3 (1766) investors would be suffering Index losses of almost 9%.

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.

What is our Model Price chart saying?

Simple, we are in the zone between EBV+3 and EBV+4, as we have been for a year and a half, and nothing much as changed. Yes, within the S&P 500 Index itself, stocks are winning and losing, based on their top line and earnings growth estimates. And this has occurred, cyclical and secular rotations, since public markets were invented.

As I have said previously we could trade down to EBV+3 some 9% lower. But would this be the end of the world? Not according to Model Price Theory. It would suggest, if we were to go there, more upside potential than downside and obviously a good reward/risk scenario for investors.

Is there anything in our Model Price chart that is worrisome? Not that I can see. As you can see the S&P 500 fell to 1867 back in the last week of August 2015. And by the end of October we were within 4% of an all time high!

Obviously the world is focused on China right now. For the last thirty years China has been nothing short of a major economic miracle. From a poor fourth world economy to a $60 trillion dollar economic behemoth and will soon rival the US for economic supremacy. Their next stage of economic development is to transition their economy from an investment lead economy to one of a middle class and consumption. In the history of the world this has not happened to any nation without a deep recession/depression. However, China is doing this transition with large amounts of foreign reserves and the best economic brainpower on the planet. As Bank of England head, Mark Carney said to Charlie Rose in an interview several years ago, it’s in everyone’s interest, globally, that this transition happen without economic repercussions for the rest of the world and every central bank is willing to help China with this transition.

The reason I mention this China has a big decision to make in relation to their currency. They have been pegged to the US dollar and have been feasting or reaping the economic benefits as the US dollar has been low compared to other currencies especially the Japanese Yen over the last few decades. However the US dollar has been rallying because, as I have said previously, the US is emerging from the financial crisis and their currency is appreciating against all other currencies worldwide. So what is China to do here? Because of the currency peg the renembi (RMB) is stronger than most of their competitors (i.e., Japan, South Korea and the like) and putting downward economic pressure on their economy.

The Chinese have been trying to devalue their currency slowly and intermittently against the US dollar over the last few months and this is causing everyone concern. Thus your seeing panic selling in the Chinese markets with ripples out to the rest of the world. For if China devalued the RMB, say 30 to 40% against the US dollar, this would send a wave of deflation out to the rest of the world as China’s manufacture goods would be competitively priced compared to other exporting countries.

And what if the US dollar rallies higher from these current levels? As readers will know I’m predicting a large and secular rally for the US dollar against all global currencies over the longer term 5-7 years. If China is having a tough time at these present levels…what happens if the US dollar rallies substantially higher?

So you can see why there is cause for concern by global investors and they are re-pricing asset prices/valuations in case things go badly.

Conclusion

As last Friday’s job numbers have pointed out the US is finally emerging out of the financial crisis that started nearly seven years ago. The problem at this particular time is much of the global economic world is monetarily out of sync and is either losing their economic strength (China and the emerging economies) or have been mired in very slow growth (Europe) over the last several years. These ‘macro’ considerations have taken over the narrative in global financial markets leaving all participants to be cautious and worried.

Hopefully this ‘marco’ narrative changes in the coming weeks as US companies start reporting their 4th quarter financial results with guidance for the rest of 2016.

Yes, the market could fall to EBV+3. And, yes the S&P 500 Index could rally up to EBV+4 and make all-time highs for the S&P Index. Good companies, will show their stuff in the coming weeks and we will see how the market reacts to possible forward fundamentals.

 

‘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).

Intel (INTC) – Model Price Analysis

What we call “Old Tech” has been on a tear in 2014.

 

Has anybody noticed?

 

Case in point has been Intel Corp. that had a positive transit of EBV+4 last week when the company reported second quarter earnings. All in all (with dividends) Intel is up almost 40% for 2014 and with a positive transit of one of our EBV Lines indicating improving corporate fundamentals and potential share gains in the future.

 

An additional fundamental positive is our calculation of model price. As you can observe from the model price chart below our calculation of fair market value for Intel is $46.25. This implies another 35% gain potential for investors sometime in the future.

 

Model Price Chart that can be found on our Facebook app 'Model Price'

Model Price Chart that can be found on our Facebook app ‘Model Price’

 

Additional Model Price Analysis

 

I was curious about Intel. Maybe something is going on here that can make me a few dollars – more than I have already made from EBV+3. I seem to recall, from the daily white noise of the business press, Intel getting into the chip (semiconductor) business for mobile phones, albeit very late in the game, combined with the fact the company has a new CEO. CEO’s are very important to the long run (secular) gains of any public company. Ask an investor in Apple since Steve Jobs returned to Apple in 1996 or long term investors in General Electric when Jack Welsh was running the company back in 1980’s and 90’s. CEOs make a big difference in rates of returns on your investments and if you can identify one early enough, invest, sit back and relax and you can enjoy a great financial ride into retirement.

 

Good CEOs leave fingerprints. Financial fingerprints. Fingerprints you can identify and see concurrently on a quarterly earnings report. Yes, we can all spot a special CEO after the fact. After this CEO added tens (and hundreds) of billions of market capitalization to the company that she runs. That’s easy.

 

In the context of investing; history is nice, but it’s the future I want to know.

 

First, I have a quick look at our long-term model price chart of Intel going back to 2007 of the Model Price Facebook app.

 

Model Price Chart that can be found on our Facebook app 'Model Price'

Model Price Chart that can be found on our Facebook app ‘Model Price’

 

Hmm… you can observe that Intel’s stock price had a positive transit of EBV+4 on two other occasions before last week. The first positive transit occurred in 2010 and the other obviously at the beginning of 2012. Interestingly both times the stock price peaked in price at mid-year before not only falling in price but also negatively transited back down through the same EBV+4. Yikes! Check your calendar; yes, it’s mid-year 2014!

 

“OK, strike one!” I say to myself.

 

But I’m still intrigued.

 

So I call up my Model Price database. My first analysis is looking at the long-term history of earnings of Intel and what is going on concurrently with Theoretical Earnings (TE). Theoretical Earnings is a financial concept particular to MPT. (For a fuller discussion of TE see ‘Key Concepts’ above.)

 

image00114

 

A few observables from the above chart

 

1. Intel’s earnings over the last twenty years have been more cyclical than I remember them.

 

2. Intel’s earnings ‘crashed’ during the financial crises of 2008 however rebounded smartly to record highs in 2012.

 

3. Looks like something happened in 2013 that caused a dip in earnings. What happened? I haven’t a clue nor do I care to find out. But a year after this dip, Intel’s earnings consolidated around the $2 a share level and look like they are returning to record highs (maybe).

 

4. Theoretical Earnings (TE) have been on a steady increase since 1995 with a dip starting in 2011 and 2012. I’m guessing here but this is probably because of share buybacks on behalf of the company. (Again I do not care why the TE is falling just that a falling TE and increasing earnings is a positive for the valuation of the company.)

 

We can look at this above chart differently.

 

I like computing a ratio between the two data series displayed above and charting the series over long periods of time. What I’m getting at with this analysis is how profitable Intel is relative to its’ own calculation of benchmarked earnings or TE. Or if you prefer the earnings of Intel relative to the size of the company’s balance sheet – a balance sheet the company’s CEO can control.

 

image0039

 

You can observe back in 1997-98 Intel was earning 9 times its TE. And having peaked at this level this ratio has fallen to a low and stable level at 2 times, plus or minus, over the last 12 years.

 

What does this mean?

 

Relative to the size of the balance sheet Intel’s earnings are quite unimpressive, somewhat stable (ignoring 2008), and a country mile from the robust years of 1997-98.

 

“Strike two!”

 

Convexity

 

The next MPT variable I call up in our Model Price database is convexity. Again you can find a definition of convexity under our ‘Key Concepts’ tab or better still I go to great lengths to discuss and define convexity in my blog on Apple and its share split (here).

 

image0052

 

Want a simple way to think of convexity? The higher the convexity number computed by Model Price Theory (MPT), the higher the valuation of the company. To crunch this number takes a lot of computer power on our part but integral to understanding the valuation mysteries of the market.   Also our convexity variable is embedded in our model price algorithm and necessary for its calculation.

 

Looking at the history of our convexity calculation you can observe that back in 1996 Intel had a convexity variable of 9 and it has been falling steadily since this peak. Again this variable is CEO controlled in the way she structures the balance sheet of the company.

 

For interest and giggles sake, with a convexity reading of 9 and a ratio of 9 times earnings versus Theoretical Earnings (TE), Intel traded at a valuation level of EBV+8 in 2000. Looking at our Facebook App for Intel shows if Intel was trading at EBV+8 today the stock price would be over $170 a share from the current $34! (Yes, that’s only a difference in market capitalization of $675 billion dollars.)

 

Both mind boggling in terms of potential gains for investors and proof what the market can reward management for good financial decision-making.

 

Irrespective of the glory days, Intel’s convexity is hitting new lows as you can observe on the above chart.

 

 

You guessed it, “Strike Three!”

 

So what does all the financial analysis mean?

 

My initial excitement on this most recent positive transit is waning. Certainly if earnings were to spike to record highs Intel could very well capture the valuation space between our model price calculation and its current trading price. Still representing a 40% upside target.

 

Not bad, yes?

 

A quick google search tells me Brian Krzanich took the reins as CEO back in May 2013. What does MPT tells us about his tenure so far? He’s no Jack Welch according to Model Price Theory (MPT).

 

Looks like just another ‘care taker’ CEO, unfortunately. I was hoping for so much more.

 

So to be clear I like Intel, and still see the value gap between where the stock is trading and our calculation of model price closing giving further gains to shareholders – see enclosed model price chart from Facebook. As of today, as I write this blog, Intel is our largest position or weight in our Acker Finley Select US 50 Fund with an unrealized gain of 47%. It’s just I was hoping or potentially intrigued that Intel may have the ability to be a 5 or 10 ‘bagger’ (5 times our original investment) that I clearly did’t see because of our above MPT analysis and hence this blog post.

July 2014 – Monthly S&P 500 Market Strategy Update

Ditto!

 

“Sorry what was that?” you say.

 

I opened last month – June 2014 – Monthly S&P 500 Market Strategy Update – with the opening, “What can one say about the US equity markets? No real volatility and hitting new highs everyday!”

 

What else can I say but the obvious…ditto!

 

As usual let’s have a look at the model price chart of the S&P 500 Index.

 

S&P 500 Index Model Price Chart

S&P 500 Index Model Price Chart

 

 

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 (2162) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1728) investors would be suffering losses of 13%.

 

This is the first time this year where the risks for the US equity investors outweigh the upside rewards since the positive transit of EBV+3 back in May of 2013.

 

Should US equity investors be alarmed? No. For me it’s just a reminder that risk is ever present and growing. I do look at my portfolio of stocks and ask, “Do I have too much?” And if I do I lighten up.

 

Of course it’s hard. Yes, I’m making tons of cash just holding my positions. But I have been in this game too long not to understand market risk. To me risk is being in a position of NOT buying more when the situation arises. Can you image having Apple (AAPL) pulling back to EBV+5 on a market pullback and NOT being in a position to buy more. That’s how I define risk. So I sell some Apple here. Make sense?

 

More than anything Model Price Theory (MPT) is about assessing risk/reward and investing a highly probable market or equity bottoms. Users of Model Price should always know where their individual equity positions are relative to their trading (EBV) zones including the overall market – S&P 500 Composite.

Since I began this blog quoting from the June market strategy blog, I will end it in the same way.

 

“So relax, take it easy because second quarter earnings are on the way and with September and October coming; these two months always seem to be eventful for one reason or another.

 

As always, see what happens.”

Goose Bumps from Our EBV Lines – Lululemon Athletica Inc. (LULU)

 

Fifteen years. Yes, fifteen years I have seen and witnessed model price math. And I still get goose bumps. Man, look at this chart from last night’s computer run. Look where the price of LULU stopped and paused. Amazing EBV+5. Think about this, EBV+5 was predetermined and computed before the stock price arrived and stopped falling. I have seen this over and over again for 15 years and I still get a thrill every time I see this. It’s magical. Tens of thousands maybe millions of people trading shares – Adam Smith’s invisible hand – and share prices conform to our EBV math.

 

Chart from our Model Price Facebook App

Chart from our Model Price Facebook App

 

How is this possible?

 

These mathematical points, these EBV lines, come from natural phenomena observed from nature – yes that’s right ‘mother nature’.

 

“Are you kidding me!” you say.

 

No I’m not.

 

If you are looking for an edge in your stock trading Model Price Theory (MPT) is a ‘new country heard from’ and very simplistic.

 

I would say elegant.

 

I get the question all the time, “How do you know these EBV work?”

 

“They just do!” I respond.

 

Not a very satisfying answer I know both for the questioner or myself. So I have to document. I have to point out the obvious whenever it happens. I have had 15 years of being amazed of how equity prices conform to these simplistic multi-colored parallel lines.

 

I have made big dollars from using these EBV Lines. It is worth your time and effort to have a look.

 

And I hope that 15 years from now you still get goose bumps, as I do, observing stock prices interact with these EBV Lines.

 

Dai-ichi Life Insurance Deal with Protective Life Confirms Model Price

What are individual stocks worth in the publicly traded equity markets?

 

This question plagued me for sometime not only early in my financial career but when I started taking finance courses in university. Would you believe the world of finance doesn’t know this basic question? Sure there is the famous ‘Discounted Cash Flow’ [DCF] calculation but having spent 5 minutes doing this calculation and the amount of guess work about time frames, normal business activity and interest rates (discount rate) makes, at least in my mind, the DCF calculation dubious and imprecise. The other well-known calculation of fair market value can be what is known as ‘Enterprise Value’. Again spend any time with this calculation, and its simplistic nature and I have always wondered whether there is a better way.

 

Unfortunately in today’s financial world, there seems to be no definitive or agreed upon technique – algorithm – about what a company is worth especially public companies. In other words, business valuation is more art (justification) than science (math).

 

Enter Model Price

 

After many years of hard work and R&D our algorithm – Model Price – was born in 2002. I have been observing our model price calculation for over 12 years. Four years ago we decided, conceptually, to release Model Price to the public on the Facebook platform. Two years ago we released our Model Price App (Application) on Facebook. This application allows the general public to view our model price calculation (and history) in our database of stocks – over 2,000 companies both Canadian and US listed – at your convenience.

 

Our algorithm – Model Price – is so robust that we can calculate model price or fair market value for all companies in our database no matter what kind of business or peculiarities a specific industry sector may inhibit, like banking/finance. In my opinion model price represents a major break-through in security analysis and helps me considerably in the evaluation of individual public companies for investment.

 

Hopefully model price can help you as well!

 

However in order for you to use model price you have to be convinced that our calculation – algorithm – is relevant.

 

How do I do this?

 

Certainly one way is to evaluate M&A activity, where independent parties come together and make acquisitions on an arms length basis. This transaction price would certainly be considered fair market value especially in the transparent world of company boards, investment bankers and various experts on both sides of the transaction.

 

Yesterday morning Japan’s Dai-ichi Life Insurance agreed to acquire Protective Life Corp. at $70 per share. What was our calculated Model Price for Protective Life you ask?

 

Here is Wednesday’s model price chart for Protective Life Corp. (PL) after the transaction was announced and our calculated model price of $70.44.

 

Protective Life with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Protective Life with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

 

Conclusion

 

Our simple dashed purple line, included on our model price charts, probably looks superficial to the sophisticated and complicated world of finance. I prefer elegant!

 

In my opinion the world of security analysis and investing becomes a much more interesting place when participants begin to realize and have confidence in what the true fair market value of a public company really is. Maybe investing becomes much more ‘rational’, at least for those who use Model Price and may have a significant impact on your net worth.

 

I have seen model price work for over 12 years. I know this simplistic purple line ‘delivers’ the goods in terms of fair market value. I also realize I need to prove to you that our calculation of model price is relevant. Hopefully this transaction and others are a step in the right direction to that result.

Other links to transactions that have confirmed our model price calculation.

Loblaw’s Deal with Shoppers Confirms our Model Price Calculation

Canada Bread – Confirming Model Price Algorithm

Warnaco (WRC) Acquisition Confirms Model Price Calculation

CVH – Aetna to buy Coventry Health. Confirmation of Model Price.

BCE – Agreed to Acquire Astral Media “A” for $50 per share

 

Death to a ‘Tape Reader’ with a Happy Ending!

 

I dropped out of the ‘technology race’ in 2001. I couldn’t do it any more. I was on the edge of total mental and physical collapse. Or let me put it this way, either I was going to have a nervous breakdown or my office was going to look like this.

 

Hum…Certainly NOT the way I wanted to spend my working days in front of!

Hum…Certainly NOT the way I wanted to spend my working days in front of!

 

I needed to rethink how my company and I were doing business and how future gains would accrue to new and future clients.

 

The Art of ‘Tape Reading’ Dies

 

I used to be a ‘tape reader’!

 

All of us in the equity business who were any good – back-in-the-day – were, so called ‘tape readers’.

 

What is a ‘tape reader’ you ask?

 

Long before computers, stock trades were recorded on a long paper rolls about 1” in diameter. As an equity trade occurred the transacted price, number of shares and a company’s stock symbol were electronically sent to a mechanical printing type of machine that would sputter ‘clickety-clack’ sounds during market hours. Brokers would spend hours reviewing this long piece of paper looking for patterns in individuals stocks. Yes, one had to have a good memory but substantial gains could be deduced by looking for trading patterns especially when thousands of shares would trade in a ‘block’, suggesting either accumulation or distribution of shares by a large trust company or pension fund. This was laughingly an old fashion version of ‘front-running’ that Michael Lewis writes about in his book Flash Boys.

 

Alternatively if I were pressed we – ‘Tape Readers’ – were mentally connecting the dots or doing simplistic forms of Technical Analysis.

 

This paper tape was replaced with a wall mounted faux-digital tape that measured some 15 feet in length. During market hours as trades were displayed, men – never women (at least I never saw any), would sit for hours looking for trends – price movement – and block trades on hundreds of stocks with a transacted price. They would mentally piece together whether a stock was being accumulated or under distribution. Over a period of a few days one could get a feel of the market as a whole. If the equity markets were being accumulated all observed stocks would have positive price movement. One could ‘feel’ how ‘healthy’ or ‘sick’ the stock market was by observing individual trades.

 

I would make it a point when walking home from high school (early to mid 1970’s), unfortunately the long way home (when I didn’t have much homework) to pass by the picture window of a large storefront location where a brokerage firm (A.E. Ames) operated a wall mounted ticker tape with about twenty chairs positioned theatrically for their clients. Anywhere from 5 to 10 old men would sit transfix to the fast moving lime green letters and numbers moving right to left ignoring a curious passerby looking on with fascination.

 

Jim Cramer – ‘Tape Reader’ in Action

 

Want another example of ‘Tape Reading’?

 

The best example I can give is Mr. Jim Cramer on his CNBC television show Mad Money. When Jim does his ‘Lightening Round’ segment that’s a ‘Tape Reader’ in action and reminds me of the old days.

 

Jim has a prodigious memory (like all ‘Tape Readers’) combined with lots of energy to try absorb each and every trade. Jim regales his audience with theatrics and bluster but after 2000 – 2001 the equity market trading internals changed and his (and my) acquired skill of ‘tape reading’ went the way of the Dodo bird.

 

What Changed?

 

Two forces came together in 1998-2000 that rendered the art of ‘Tape Reading’, that ruled Wall Street for over 100 years, meaningless. The first was computer technology, fiber optics and instant mathematical analytics. The second was the frenzied volume and the hundreds of new companies ‘IPOed’ in the technology bubble of 1998-2000. If there was an old fashion wall mounted ticker tape the symbols, price and the amount of shares would zip by at such a lightening speed I doubt that any human being would be able to discern any information.

 

Like a proverbial caged hamster on his running wheel and unbeknownst to the hamster no amount of running speed the animal could ever expel would allow for the animal to keep up with the increasing speed of the wheeled contraption.

 

Jim gave up managing money and went into show business. I walked off the trading floor I built at Acker Finley and moved into a small office exhausted. All I had was an Internet connection and a burning desire to start over.

 

Starting Over or Act II

 

I like to compare the investment business to that of a miner. Everyone in the trading and equity analysis business tunnels down the same mineshaft. I reasoned back some 15 years ago this metaphorical mineshaft would lead to its ultimate conclusion. Where millisecond algorithmic trading by the fastest and most expensive technology wins at the end of the day. In this world, today’s world, first place wins everything second place goes bankrupt (Yikes!). As for Fundamental and Technical Analysis, nothing has changed in these two fields since the mid-sixty’s! Yes, you read this right.

 

As a miner – keeping with my analogy, I gave up digging where the rest of the industry was tunneling. Picked up my shovel and digging materials and started tunneling a new mineshaft of my own. We at Acker Finley just completed our math on Model Price Theory (MPT) about this time – 15 years ago – and I jumped in with both feet. What you see today on our Facebook App ‘Model Price’ is what I started with back in 2001.

 

Conclusion

 

All industries including the financial industry are impacted by technological change. Wall and Bay Street lived in a cloistered world for over 100 years where the ‘inmates’ tightly controlled everything to do with equity trading. This all changed in 2000. What is amazing and what I ask myself daily is did anyone notice this transition? Certainly by watching financial professionals on television I doubt whether substantial intellectual career transitions were made. At least Cramer is honest enough to know his market edge disappeared and transformed his career as a showman and NOT an investment professional.

 

Which mine shaft are you mining for your investment ideas or strategies? Today’s CFA or MBA and CMT (Chartered Market Technician) investment professionals think the road to riches is paved by relearning past financial concepts either in Fundamental or Technical Analysis. Really? Is there any more ore to be found at the end of this long and well-mined mineshaft? What is your advantage trading and investing in today’s equities?

 

(I write this blog NOT to be ‘preachy’, but if you are suffering from a string of investment and trading losses maybe this blog will give you something to think about.)

 

 

P.S. I thought I would include a picture of my trading station in 2014. What does your trading station look like?

I feel better sitting in front of this computer screen, anywhere in the world!  You?

I feel better sitting in front of this computer screen, anywhere in the world! You?

Valeant (VRX) – Announces $50 Billion Hostile Deal for Allergan, Inc. (AGN)

Picture this.

At high noon, a majestic and lone antelope on the wide-open plains of the Serengeti is peacefully grazing on the wispy wind blown grass.

Then BANG!

A bullet pierces the heart of the young antelope not knowing a big game hunter looking for his next trophy has shot it. The poor dying animal not only struggles physically but also is mentally confused thinking its well being was protected by its multi-billion dollar market capitalization and substantial premium market valuation.

The panicked antelope gets a glimpse of two men approaching from behind scrub bushes. The hunter, the one with the rifle, being one J. Michael Pearson of Valeant Pharmaceuticals and his partner, one Mr. Bill Ackman, to me better known as Bill “The Butcher” Cutting from the movie “The Gangs of New York”.

Mr. Bill

Mr. Bill “The Butcher” Cutting

The young antelope is, you guessed it, Allergan Inc.

Financial Engineering versus R&D and Innovation

Financial engineering – making barrels full of money – can and will trump everything, even reason. When one has the financial math, or the golden keys if you will, why not use them?

J. Michael Pearson seemingly knows the financial math and is building an empire. Mr. Pearson has acquired through Valeant over 100 acquisitions since becoming CEO back in 2008. I have borrowed Mr. Ackman’s ‘PowerPoint’ slide depicting the concurrent history of Valeant’s CEO, Mr. Pearson and the company’s stock price with a few noted acquisitions annotated for your convenience.

I copied this chart from Mr. Bill Ackman's 'PowerPoint' presentation to investors.

I copied this chart from Mr. Bill Ackman’s ‘PowerPoint’ presentation to investors.

Valeant, the company, and its activities are known as a ‘Rollup’. What is a ‘Rollup’ you ask? A ’Rollup’ is where multiple small companies in the same market are acquired and merged together by a consolidator. In this case the consolidator is Valeant and its mastermind is one Mr. Pearson. See my original blog about Valeant and its activities here and a reblog (with new financial data) here.

Financial history is filled with ‘Rollups’. Usually the consolidating company and its mastermind – the protagonist behind the company – is very successful in the beginning and during the numerous acquisitions the consolidator completes. Valeant, the company, and Mr. Pearson maybe new to business history stage but their corporate acquisition activities are NOT new to the annals of business history.

The difficulty behind ‘Rollups’ and ultimately its undoing – failure – is the complex financial math behind the consolidator’s acquisition activities. In my original blog I identified the protagonist, J. Michael Pearson, as an individual who potentially may have figured out the financial math behind doing hundreds of acquisitions with a steadily climbing stock price rewarding him and common shareholders. Readers have to admit I wasn’t wrong in my assessment. See once a protagonist – Pearson – and the consolidator – Valeant – gets on a roll (no pun intended), why stop? The financial math works proportionately irrespective of the magnitude. Hundreds of thousands of dollars can turn into multi-billions and the math still works except for the inconvenience of dealing with the zeros and commas.

With this in mind, Mr. Pearson is reaching all the way for the $50 billion acquisition instead of playing around with an acquisition in the small mid double digit billion. And why not? Mr. Pearson has a solid track record from previous acquisitions and has earned market credibility proving he knows the financial math to make his ‘rollup’ vehicle, Valeant, successful by making shareholders money.

Allergan, Inc. is a company that has a corporate culture prized and steeped in science. A full 17% of Allergan’s revenue is spent on research and development, higher than many of its rivals. Valeant claims to have spent 3% of its revenue on R&D last year but with revenues growing as quickly as the acquisitions were completed and costs slashed as fast as possible one has to give a ‘Spockian’ eyebrow to this percentage. Pearson reassured investors that $2.7 billion in cost savings could be realized from the acquisition of Allergan, Inc.

So much for Allergan’s R&D!

As Bud Fox asked Gordon Gekko in the movie Wall Street, “Why do you need to wreck this company?”

“Because it’s WRECKABLE, all right?” yells Gekko!

Enter Bill “The Butcher” Cutting – Bill Ackman

Looking at his acquisition strategy chessboard Mr. Pearson probably thought about my metaphor of the antelope (just kidding) in that Allergan in the flickering of life between the bullet in the heart and death itself still maybe saved. First, the numbers are getting too big to hide and an acquisition as big as this will attract a lot of financial press. And secondly, Allergan could play the sympathetic ‘Little Red Ridinghood’ card and wrap them selves in scientific innovation helping humankind type of company that will be destroyed by the big bad wolf (Valeant’s greedy ‘Rollup’ financial machine).

Mr. Pearson is smart enough to know this acquisition fight will be fought at the “Five Points” district in lower Manhattan. (OK, yes this fight will occur in the canyons of Wall Street…but Five Points is relatively close and it follows the story line of my analogy so I’m going with it!) And with any fight, especially a knife fight, you need an antagonist. An antagonist that is totally crazy with greasy hair and blood on his apron. An antagonist who will sharpen his knives, axes and isn’t afraid to die especially in front of the countless lawyers and investment bankers Pearson and company will have to deal with to get this deal done.

“The Butcher” and his gang doing what they do best. Anybody want to fight?

Pearson (Valeant) and Ackman (Pershing Square) form a Partnership (PS Fund 1)

So Mr. Pearson tells Mr. Ackman of his plans to tender a hostile bid for Allergan after the two were introduced. Together through their respective companies they setup a partnership called PS Fund 1. Valeant chips in $76 million in cash into the Partnership – PS Fund 1. Pershing Square, through the partnership, quickly amassed a 9.7% stake in Allergan, much through the purchase of stock options – very little capital required. On April 22nd Valeant launched their hostile takeover bid for Allergan, Inc. pushing shares of AGN up to $168 – as of Friday’s close April 25th. The true cost of the 9.7% – 10% being the legal limit – stake in Allergan by the partnership has not been disclosed but for the sake of round numbers let’s say the partnership of PS Fund 1 profit is $35 per share. With some 29 million shares controlled by the partnership that’s a cool profit of $1 billion dollars. If a ‘white knight’ appears on the scene and bids a higher price than Valeant and wins Allergan, Valeant gets its money back, $76 million, and 15% of any profit the transaction yields. Of course ‘The Butcher’ and his clients get the rest.

Isn’t this insider trading? How could this be legal you ask? Well, Bill “The Butcher” Cutting’s lawyer – Robert Khuzami – former director of enforcement at the SEC – vetted the Valeant partnership (PS Fund 1) and deemed it legal.

“Folks, it’s smart people like me who make America great.”

Allergan probably could have defended itself against Valeant however with the two of them the heartbeat of my young antelope is growing fainter, indeed.

Conclusion

How do you feel about ‘Financial Engineering’ now! Is this capitalism at its’ finest or something else? I will leave the moral and ethical judgments to you. In no particular order here are my conclusions.

  1. Call and book the taxidermist. In my opinion Allergan has limited options available to keep themselves independent. The CEO of Allergan could recapitalize the company – pay a huge dividend to shareholders with debt – and perform the necessary self-mutilation in terms of employee layoffs and reduced R&D spending planned by Mr. Pearson and Valeant to remain independent. The other option is, of course, a ‘white knight’, a company of Allergan’s choosing to purchase Allergan at a premium to Valeant’s bid. This ‘white knight’ will have to be careful though. If the CEO’s ‘white knight’ purchase is a vanity purchase and the company’s share price gets crushed because the market doesn’t like the acquisition – the acquisition numbers don’t work – then the ‘white knight’ company maybe the next target for Pearson, Ackman and Company. After one antelope has been shot and two humans are walking around the Serengeti the other animals – pharmaceutical companies – will be visibly nervous.
  1. I spent all Tuesday afternoon, the day of the formal bid, April 22nd, using Model Price Theory (MPT) and pushing around some of the numbers on Valeant’s pro forma balance sheet if this Allergan deal gets done with the announced numbers. Shockingly the numbers work! Investors and equity market observers might have deduced this because Valeant’s share price appreciated on the announcement of the deal. It amazes me how the market, within seconds of an announced deal can make a snap judgment – and a correct judgment – whether the announced deal is beneficial to the acquiring company’s market value or model price. Mr. Pearson is a financial engineering genius my friends and I have the math to prove it!
  1. If Valeant’s acquires Allergan, Inc. Bill Ackman and his investors will invest $4 billion in Valeant’s shares with board representation. This is no surprise to me. Bill wants to get closer to the action. Maybe pick up some financial engineering math from his new friend Mr. Pearson. To repeat what I said earlier if the financial math works the magnitude of the numbers are of no consequence. Will the boys, Pearson and Ackman, be happy after this $50 billion dollar Allergan deal gets completed? Of course not! There are still bigger deals to do. How about a $100 billion dollar deal?
  1. What’s the end game for Valeant, you may ask? Rollups finally get crushed under their own weight. The numbers just get too large. Or maybe in this situation there are no more publicly available pharmaceutical companies to acquire. There is only a hand full of elephants out there after all. Merck has a market capitalization of $167 billion, and Pfizer $196 billion. And both companies are trading below our calculated model price or fair market value. If this Allergan deal gets done, Mr. Pearson and his new best friend, I’m sure, will be getting restless and will be looking for bigger game grazing on the Serengeti. After all a new business history can be written here and isn’t making future history more important then money?

P.S.      Friends I would be remiss if I didn’t point out the obvious here. In February 2008 one J. Michael Pearson started out as a lowly CEO of a generic pharmaceutical company with $5 million in Valeant company stock. Today, after short 6 years, Mr. Pearson is now a billionaire financier – yes, he is worth over a billion dollars – and CEO of a public company that will have a market capitalization of $75 billion US dollars if Valeant gets the acquisition of Allergan done. Truly amazing, especially considering that global growth hasn’t been stellar since the Financial Crash of 2008.  What have you been doing over the last six years?

You want to be rich like Warren Buffett? Read This! – Reblog

Energy companies are ‘jiggy’ my friends on both sides of the border. The number of energy companies making new 52 – week highs is astonishing. Please take your time and ‘Speed Chart’ your way through the ‘SP500 Energy’ sub index of the S&P 500 and the ‘S&P/TSX 60 Index’ for valuable possible investable ideas. Large capitalized energy companies, after years of sub par returns, are having positive transits and should not be ignored.

I blogged about Exxon Mobil Corporation back in November, when Mr. Buffett made a very shrewd and well timed investment – would expect anything different! At the time of the Buffett investment and my blog, it was later disclosed that infamous short seller Jim Chanos had a short position on the same Exxon Mobil!

Huh?

(P.S. Hope you enjoying your Easter Sunday!)

Last Thursday Warren Buffett, chairman and CEO of Berkshire Hathaway, reported his third quarter portfolio update.  He, or one of his hired fund managers Todd Combs or Ted Weschler, reported holding a new stock position in the third quarter: Exxon Mobil Corporation.  The size of the position suggests that it is a Buffett position.

Berkshire reported owning Exxon Mobil in the third quarter in an amended filing, but actually first bought the stock in the second quarter without filing, and hid the fact until now.  In the second quarter he bought 31,244,110 shares.  In the third, it added 8,845,261.  The average share prices for the two quarters were both $90.

As always when I hear such an announcement I rush to my model price charts to see what is happening and for a quick analysis.  I didn’t have to for Exxon Mobil, this model price chart is well known to me and Buffet’s purchase makes all the sense in the world.

If you want to be a successful investor in real estate the cliché is “Location, Location, Location”.  To emulate Warren Buffett in the equity markets you have to know Valuation, Valuation, Valuation (and tax-free compounding).  The business press will always tell you who, what, when and the where.  I will disclose the why and the how!  Let’s have a look at Warren’s playbook.

First, let me show you our super long-term model price chart from our database for Exxon Mobil.

Exxon Mobil with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Exxon Mobil with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

 

As you can see our model price chart goes back to 1995, some 18 years.  I have annotated by ‘up’ arrows only two other times – 1995 and 2010 – that Exxon Mobil traded at the same EBV level that Mr. Buffett made his most recent purchase of XOM (EBV+3).

One of America’s largest and best-managed public companies is trading at a valuation only seen twice before over the last 18 years.  Mr. Buffett used this valuation level to purchase a sizable stake in the company.  This is why Mr. Buffett is one of the wealthiest men in the world.  The market is, for whatever reason, placing a valuation on Exxon Mobil that rarely occurs.  First, Mr. Buffett recognizes this fact and has the investment capital to take advantage of the situation.

Another secret of Warren’s that rarely ever gets any coverage is the man rarely, if ever, sells his main positions.  Warren has two things working for him when making an investment, the first is the valuation level of his purchase and the second is tax free compounding as the book value of the company goes up over time – as you can see in our model price chart in that our EBV (parallel multi-colored lines) slope upward on a logarithmic scale.  Another bonus is Exxon Mobil pays a dividend of 2.64% in line with 10 year US treasuries.

To summarize, Warren’s has some cash lying around.  One of the best-managed companies in the world, a company that can trace its roots to John D. Rockefeller, is trading at a valuation that’s only occurred twice before in the last 18 years.  Plus as an added bonus Exxon pays out a yield of 2.64% –  same yield one receives on US Treasury bonds.  (In ten years the US Treasury gives you your money back, one can only speculate what the value of Warren’s shareholding of XOM would be and the future yield the company would be paying.)

This is how the rich get richer my friends!

NASDAQ Finds Support at EBV+5

Sometimes pictures can say a thousand words.

 

NASDAQ 100 Stock Index with weekly price bars and EBV Lines (colored lines).

NASDAQ 100 Stock Index with weekly price bars and EBV Lines (colored lines).

 

Enough said.

P.S. I hoped everyone noticed the ‘Chicken Littles’ in the news media have gone from hysterics to calmness once the NASDAQ market found support.

P.S.S. Twitter and the ‘Echo Chamber’ of the usual suspects last week when the NASDAQ stocks were declining.

 

Voila_Capture 2014-04-16_12-47-51_PM

 

Voila_Capture 2014-04-16_12-49-06_PM

 

Corrections don’t matter anymore…I guess they can’t get peoples attention unless they say the word ‘crash’!