Tag Archives: how are EBV lines useful to you as an investor

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.

 

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.

February 2015 – Monthly S&P 500 Market Strategy Update

Are the global central banks playing chess or checkers?

January saw an unprecedented amount of central bank activity. By Zero Hedge’s count a total of 14 independent national central banks, including Canada, eased interest rates in the first month of 2015. So the market focus was not on equities per se but on the global macro view that any experienced market watcher would have to admit is cloudy to say the least.

Central banks are the elephants in the global finance circus and their actions have significant consequences to global fund flows and ultimately asset pricing. So to have the absolute number and the actions of so many of these institutions is unprecedented.

However have a look at our model price chart for the S&P 500 and you see an equity market that is patiently waiting for all the fireworks to die down and a hair’s breath under all time highs set in December.

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 (2196) this would represent a gain of some 6.5%. If the market corrected back to EBV+3 (1756) investors would be suffering losses of almost 15%.

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.

So what are my observations for the month of January 2015?

The U.S. equity market is waiting. It’s being patient. Central banks the world over are doing stuff…mainly lower interest rates and quantitative easing…and the U.S. market is waiting for the impact or the result of all these actions.

No big deal….

And as far as answering the question of which board game the central banks are playing? I’m not sure, and willing to bet that central bankers have to improvise and modify what they are doing in different time periods as the economic analysis indicates. My point is that US equity markets seem happy to be patient and don’t really care which game their playing. And if the US equity markets are happy so am I.

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!

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!

 

 

 

 

 

 

 

 

 

 

 

 

November 2014, S&P/TSX Composite Market Strategy Update

My friends this Canadian Index is far more interesting to talk about!

The last month and a half has been brutal to all commodities especially gold. As I have noted in previous blogs the sub-index sectors of Energy and Materials (which includes gold stocks) represents 36% of the Canadian Composite Index weightings compared to 13% of the S&P 500 Index. With such a large weighting in commodities obviously the S&P/TSX Composite Index has been adversely impacted.

Model Price Chart of the S&P/TSX Composite Index

 

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

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

 

The first very apparent observation you can make of the above model price chart is the negative transit of EBV+2 in the middle of October – annotated by the arrow.

This is significant.

Negative transits, as I have written about many times, indicates a change in fundamentals. Unfortunately, as longtime followers of Model Price Theory [MPT] know, negative transits usually corresponds to negative future economic fundamentals.

I have said numerous times Model Price Theory [MPT] is NOT ‘Technical Analysis’ in the traditional sense however because we extensively use price graphs to display mathematical fundamentals repeatable ‘graphical formations’ are inevitable.

Keen observers will note that this Composite Index closed above our EBV+2 line on the same week as the negative transit. Unfortunately this is a normal repeatable ‘graphical formation’ of negative transits and I’m speaking with 15 years of experience here.

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 weeks/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.

Do I have your attention!

Does this mean the world comes to an end? Of course not! It’s just that an investor/trader has to adjust their expectations. My most profitable trading has occurred in BEAR markets of the past. You just have to know what kind of market you are in (Bull market vs. Bear) when trades are initiated and rates of return are assessed.

CONCLUSION

The last couple of months in the Canadian market have been interesting and eventful from a Model Price Theory [MPT] prospective. The highly cyclical market weight portion of the S&P/TSX Composite has been “taken out to the woodshed and shot.” Because of the negative transit of EBV+2 in the middle of October, market participants in Canadian equities should be on guard for a second negative transit that would be a negative sign and possible signaling of negative markets in the future. (As of this writing if the S&P/TSX Composite Index fell below an index level of 14,329 a second negative transit would have resulted.) Can you make money in BEAR markets…absolutely. Model Price will lead the way!

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.

Badger Daylighting – Catching Lighting in a Bottle

Yes, it has a funny name but big gains were made from investing in this company over the last year and a half.

We are a society that hunts for and admires winners. And when a stock climbs in a parabolic fashion we have no problem recognizing what a winner looks like.

We live in an information culture and there’s so much information that you have to feel inadequate at least some of the time. Badger, I have to admit, came from left field for me. I never heard of the company until mid way through 2013. Cable television shows, financial media – both print and the Internet – are all pushing to get your attention and making sure you and everybody else know who the winners are.

And I love looking for and actively seek out big stock winners like Badger. They attract what I call “heat” or “buzz”. Like a moth attracted to a night light investors/traders want to know everything there is to know about a winning stock – the management, the product and growth prospects in this very slow national economy. And of course the word brilliant is used a lot. One will hear the business press use the words ‘brilliant management’, ‘the best product ever to hit the market’, and of course ‘unlimited growth potential’.

But valuation is a two edged sword. The higher the stock rises the more the company has to do to maintain everyone’s expectations. And in the end an impossible task to fulfill or a self-fulfilling prophecy.

From my experience investors can’t resist such temptations. We all want to belong. We want to be part of the action. In our capitalist society you can belong by purchasing the winning company’s shares with our hard earned cash. And if you don’t have enough money the investment industry will lend it to you – happily. Leverage? Yes sir…step right up!

And of course a surging stock price confirms what you already know. It’s seems circular and self-reinforcing.

And once we’re an owner you are part of the story. You’re smart because you’re part of a group of people who are smart. The business press and a surging stock price confirm this to yourself and others you have told at the proverbial Saturday night cocktail party where your closest friends or relatives are impressed by your business acumen.

You’re a winner by default because you’re an owner.

And I could go on. You put the stock in your iPhone portfolio tracker. You become mesmerized by the flicking stock price, tick by tick. You see every research report, listen to the quarterly conference call, and check ‘StockTwits’ once an hour to see every tweet.

And lastly, you start personalizing your gains. Think of a bigger house, family vacation or that new sports car you always wanted.

And your stock starts to go down!

But when do you sell?

Yikes, nobody wants to talk about selling because selling is hard. Like leaving the poker table with your pockets full. It never happens.

And when the stock starts to go down, you can’t sell. You know the story too well. You spent how many hours doing what you consider research. You know everything there is to know about the stock, about the industry and management but the stock continues to slide and the losses continue to escalate. (You calculate your losses from the 52-week high NOT from your purchase price because you could have sold at the high, couldn’t you? That money was yours to take but you didn’t, did you?)

And of course, the dreaded realization “When this stock price recovers and I can get my money back I will sell the position.”

I digress.

Badger Daylighting has had one hell of a ride. Let’s take a look at the long-term model price chart of BAD.

Badger Daylighting with monthly price bars, EBV Lines (colored lines) and model price ( purple dashed line)

Badger Daylighting with monthly price bars, EBV Lines (colored lines) and model price ( purple dashed line)

 

Observables from the above chart

 

  1. Interesting to note that Badger bottomed at EBV+2 back at the market lows in March 2009. Over the last 5 years the stock has risen from EBV+2 to over EBV+7. Giving both investors and management one hell of a ride and tremendous gains.

 

  1. Badger tried and failed to positively transit from EBV+4 at points ‘A’ and ‘B’ annotated on the model price chart above. Note that are calculation of model price supported such a transit.

 

  1. Finally at the end of 2012, Badger had a positive transit of EBV+4 and according to MPT [Model Price Theory] a buy signal.

 

  1. As Badger stock price rockets upward there are multiple positive transits after the first positive transit noted in observation number 3. The stock transited through EBVs 5,6 and 7 giving investors holding the stock confidence of future gains and good entry points for traders/investors who wanted to initiate a position in the company.

 

  1. Our calculation of model price, or our definition of fair market value, is supporting the upward movement in the stock price up to a point – it begins to flatten out at EBV+6.

 

  1. Our calculation of model price may stop at EBV+6 but Badger’s stock price continues higher as momentum traders’ pile in hoping for more and fast gains.

 

Transitioning to our short-term Model Price Chart below

Badger Daylighting with weekly price bars, EBV Lines (colored lines) and model price (purple dashed line)

Badger Daylighting with weekly price bars, EBV Lines (colored lines) and model price (purple dashed line)

 

Observables

 

  1. As you can observe Badger had a positive transit of EBV+7 in the first week of April 2014. And after spending 6 weeks above EBV+7 the stock had a negative transit in the middle of May. This is the first negative transit for Badger since 2008-09 and according to MPT [Model Price Theory] a sell signal.

 

  1. Badger tried and failed to rally back and over EBV+7 in June. This is a classic retest where investors/traders think Badger is cheap on a pull back only to find the stock goes lower in the future.

 

  1. The second sell signal for Badger comes this past week with another negative transit of EBV+6. And obviously Badger starts trading lower than our calculated model price. This, at least, is one positive but usually in these broken momentum stock stories substantial value has to be created in order for new money flows to come in and buy the name.

 

Conclusion

How many times have I seen stocks like Badger over my career? Hundreds of times would probably understate my experience.

But through the prism of Model Price Theory [MPT] you can be resistant to such stock moves. Oh sure, you can trade/play/invest in these stocks, as I have over the years. But you know these situations will probably end badly for most people. Yes, you get a feeling of schadenfreude because the happiness everyone feels with today’s winners will be just as painful for many people down the road as the stock turns lower.

Am I predicting disaster for Badger?

No!

I’m just following and observing a negative transit – actually 2 negative transits but who’s counting! Like when the tides recede one can’t tell what is going on by looking at the shoreline close up. One needs a broader perspective and hopefully a fixed marker to gauge what is happening to the water level for clarity.

Our EBV levels give you this fundamental certainty and from my experience the best sell signals in finance.

A Closer Look at the S&P/TSX Energy Sub-Index

Yes, we have model price charts of each of the sub-groups making up both the S&P 500 and the S&P/TSX Composite Indices.

 

So let’s have a look at our super-long term model price chart of the S&P/TSX Energy Sub-Group.

 

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

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

 

Observables

 

  1. Looking at 19 years of history gives observers a sense of the valuation distribution of the Canadian energy sector. Back in 2005 to 2007 ‘oil patch’ equity valuations, as an index, reached a high of EBV+5. On the low side, except for a brief period in 2008 and 2009, EBV+2 seems to be the valuation lows achieved in 1999, 2011 and recently at the end of 2013.

 

  1. In general this Energy Sub-Group, as an index, seems to follow EBV+3 most of the time. Yes, when crude pricing and probably M&A activity are favorable valuations stretch over EBV+3. However when a secular bear market hits the sector this sub-group spends considerable amounts of time under our ‘Red Line’ or EBV+3.

 

  1. After the market decline and worldwide slowdown in 2000, and starting in late 2002 this Energy Index started in the valuation zone of EBV+2 and EBV+3 (the same valuation level as today – see ‘up’ arrow on chart) and rallied all the way up to EBV+5.

 

A Closer Look

 

Here are our short-term or weekly price bars of the S&P/TSX Energy Index model price chart.

 

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

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

 

  1. As you can observe this energy sub-index used our calculated EBV+2 as support for the month of December 2013 and into 2014. Again as you can observe since mid-February this index ‘ lifted off ‘ from EBV+2 for a nice gain.

 

  1. From April 21st, 2014 this energy sub-index has 22% upside potential to EBV+3 or Red Line.

 

  1. For fun, today’s current value of EBV+5 is 6043. Yes, that’s a full 82% above current levels.

 

Conclusion

The energy sector in Canada has been on a tear since mid-February. Large capitalized oil stocks like Suncor, CDN Natural Recourses, and EnCana have been moving upwards after many years in the doldrums. Just like 2002, the worldwide economy was recovering from an economic setback delivered by the equity – technology – crash in 2000. The circumstances in terms of worldwide growth for 2002 and today are quite similar and one could reasonably argue that the economic contraction of 2008 was certainly deeper than any economic recession experienced since the Great Depression. As global growth accelerates so does the worldwide demand for hydrocarbons.

 

Yes, Canadian energy stocks are starting to move upwards since mid-February. But if worldwide global growth starts to accelerate, this sector and sub-index do have a long way to run if this current period is any way analogous to 2002 to 2007.