“Bill” has asked me a couple of times to post a long-term chart of the S&P 500 with its EBV lines in the comment section of the Model Price blog.
Well here it is!
S&P 500 Index Chart – Monthly Price Bars – From 1995 to Present
S&P 500 Index with monthly price bars, and EBV Lines (colored lines).
Granted, there is a lot going on with this chart so let me list my observables to help you interrupted what you are seeing.
First, as I have said many times, this chart represents an aggregate of all designated (at the time) S&P 500 companies by market weight, from a bottom up basis. This chart is instructive on where the S&P Index is trading relative to its Economic Book Value or EBV lines. This chart can be viewed in the same way as individual company’s model price chart in that transits either positive or negative will give a general indication on the direction of the market as a whole.
My Three Observables
1. Let’s talk about the Economic Book Value (EBV) lines first off. Note how they slant up on a 45% angle. These EBV lines represent the growth in the balance sheets of all the companies in the S&P 500. Plotted on a logarithmic scale an observer can see the very important compounding that is taking place of all companies in the S&P 500 Index as a whole. This compounding, which you can see from our model price chart, is truly a wonder in our capitalist market driven world and one of the main drivers of wealth creation for society as a whole.
Two other observations of our EBV lines are notable. First is how relatively flat our EBV lines are around 2001 and 2002. This flatness or non-growth occurred as companies wrote off assets, primarily goodwill, that was recorded when acquisitions and business combinations were commonplace in the “Tech Bubble” of 2000. Time Warner/AOL merger was a poster child for M & A activity in this period. Massive goodwill was recorded as an asset of the combined company when these two entities merged with much hoopla. Resulting in massive write offs of this same goodwill when planned synergies didn’t occur in the market decline in 2001 – 2002.
The second observation is the downward slopping EBV lines from the end of 2007 through 2008. These downward slopping EBV lines represent write off of assets, and companies going insolvent during this period. The insolvency of Lehman Brothers, AIG and General Motors may ring a bell. Additional write downs were incurred of financial assets of companies surviving the financial crisis of 2008 as well – the massive deleveraging of the Too Big To Fail (TBTF) banks as an example. This EBV dip represents hundreds of billions of dollars of impaired assets written off of balance sheets of companies in the S&P 500. As you can see once the write offs were complete the EBV lines of the Index companies resume their compounding albeit at a lower EBV level than the EBV highs in 2007.
2. Is the S&P 500 Index forming a triple-top or possible “break-out” to new absolute highs for the Index? For technical investors this seems to be the number one question. How can our model price chart help with the answer? Simple, it is a question of valuation. Let’s have a look at our model price chart a little closer. The first top occurred back in 2000. Notice the market, the S&P 500, almost reached EBV+6! The second top, as you can see, occurred in 2007 at EBV+4. Currently, the S&P 500 is trading underneath EBV+3. Assuming the market does break out to new highs is this cause or reason for concern? No, in my opinion. Why? The valuation on this possible third breakout is considerably lower than the previous two highs noted above.
One of the great attributes of our model price charts is we can extend where are EBV lines will be one or two years out to 2015. As you can see EBV+3 will be somewhat higher then the current year or 2013. So even if the valuation of the S&P 500 stays the same relative place within the zone, just under EBV+3, new highs will be reached recognizing the underlying growth (compounding) of the company’s balance sheets in the future. In other words, it’s just a matter of time.
For fun let’s have a look at a normal graph of the S&P 500 Index. See graph below. You can see why chartists or technical analysts are having a field day saying the end is nigh, just like 2000 and 2007.
3. Another observation that stands out on our model price chart and is observable on the regular chart – but less so – is the last four corrections since the market bottomed in March of 2009. I have highlighted these bottoms on our model price chart. Notice how higher bottoms were made over the last almost 4 years. I call this rather “saw tooth” market action a bullish indicator and as I have been highlighting this pattern in my monthly market blogs. If a correction were to start again, this pull back should be somewhat contained and less violent than the previous four (just guessing but seems logical) as investors feel more comfortable buying dips on equity prices as time goes on.
Perspective
When it comes to the financial markets just about everyone including the financial press seems too focused on the daily news and lose sight of longer-term perspectives. It is no secret that retail investors and sophisticated pension funds have moved out of equities because they are unpredictable, volatile and low compound returns based on the last 10 years.
Fine.
What about the valuation of equities? From 1995 to 2008, the S&P 500 consistently traded above EBV+3. Other than the spike down to EBV+1 in early 2009, the S&P has been trading in the zone between EBV+2 and EBV+3 since the low in March of 2009. As you can see the Index has bounced off of EBV+3 on numerous occasions since 2010 without a positive transit. Time will tell but a positive transit seems inevitable as the US economy regains its footing and powers forward. Once a transit of EBV+3 does occur, this is my mind would be a significant event and a precursor of much higher equity prices in the foreseeable future.
For the last 18 years this one chart can quickly sum up what has transpired in the US equity markets in terms of valuation and what is occurring with company balance sheets as a whole. I also believe this model price chart can give you an educated guess on the future direction of US equity markets. Is there one chart in finance that can give you this perspective other than our model price chart? I haven’t seen it, have you?
Model Price 