When the global central banks want asset values to go up…. They go up!
As I noted in my last blog, we have seen unprecedented central bank activity so far in 2015 resulting in – no surprise – higher asset (equity) values especially in the United States.
Can asset prices go up forever? Or better still can confidence in the men and women who control central bank activities go any higher when everyone in the investment community is already giving them a standing ovation?
Let’s have a look at our Model Price chart to look for clues on how far asset pricing can go.
S&P 500 Index with weekly price bars and EBV Lines (colored lines).
As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.
As you can observe the US market, as defined by the S&P 500, is now at the top of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2175) this would represent a gain of some 2.7%. If the market corrected back to EBV+3 (1739) investors would be suffering losses of almost 18%.
For people new to Model Price Theory [MPT] the index value or equity price can move within an EBV zone with no real consequence. However when a transit occurs – index value or equity price crosses one of our parallel lines – our EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.
Top of Zone EBV+4
I believe it’s fair to say we are finally at the top of the zone (EBV+4). Viewing the market this way, call it my first iteration; this is what I believe is the “top” in the U.S. market – valuation wise.
Long time readers of this blog have seen our long-term model price chart on the S&P 500 Index a few times previously but I include it below to illustrate that even if I view EBV+4 as the “top” of the S&P 500 Index in terms of valuation the market can crawl along just underneath our calculated EBV line for a number of years as the market index did from 2003 to 2007.
Long-term Model Price chart of the S&P 500.
S&P 500 Index with monthly price bars and EBV Lines (colored lines).
Sharp-eyed observers will notice that our EBV+4 line (black line between the ‘Red’ line and ‘Yellow’ EBV line) continues on after the last price bar as of March 2, 2015. We project out our estimation of our EBV line by calculating from a bottom up basis or company-by-company basis adding daily pro-rated mean estimates to each company’s net worth less stated dividends and calculate (forecast, if you will) what our EBV values will look like. We do this on a daily basis to incorporate all the latest changes in company fundamentals within each index.
Our calculation of EBV+4, for March of 2016, is 2378. From the March 2, 2015 close (2117) this suggests an implied rate of return of 12% just on the growth of book values (net of dividends, of course) in the S&P 500 Index. Add in a further 2% for dividends and an investor can guesstimate an implied upside for U.S. equities of 14% without any increase in valuation if things go swimmingly.
But one has to ask the most obvious of questions.
Could the S&P 500 have a positive transit of EBV+4?
This is the second iteration an investor has to consider. Again, as sharp-eyed readers can observe back in 1995, the S&P 500 Index was following along the same EBV+4, when it lifted-off and the index ran up to EBV+5 in 1997. As a matter of fact, as you can see from our long-term model price chart, the S&P 500 index almost made it to our calculated EBV+6, calculated back in the day!
The question has to be asked: Was the economic scenarios or environment different in the 1995-2000 period from the 2002-2007 period?
The answer is a resounding yes!
What was the difference?
The U.S. dollar!
Below is a long-term chart of the U.S. Dollar Index (DXY) from Bloomberg.
U.S. Dollar Index (DXY)
I have annotated on this chart the various Bull/Bear market cycles of the U.S. Dollar (DXY Index) coinciding with each U.S. President.
Hopefully, you can clearly see the difference between the two equity bull markets of 1995-2000 and 2002-2007 periods. The first, 1995-2000 equity bull market, occurred while the U.S. dollar was also in a bull period, while the second, 2002-2007 equity bull market occurred while the U.S. Dollar Index was going down or in a bear market.
I have been on record, certainly on BNN and other media outlets, that I believe the fundamentals are in place that we can see a value on the U.S. Dollar Index that would rival the Ronald Reagan Bull Market of the U.S. Dollar Index at over 160. (Maybe this is a little optimistic but certainly Clinton’s Bull Market rally to over 120 would certainly work in my analysis.)
When global money flows pour into the U.S. Dollar, as momentum is starting to pick up since December 2014, global investors will look for U.S. dollar dominated assets to park their cash. Yes, the U.S. Treasury market is an obvious choice but certainly some money flows will seek out the S&P 500 Index ETFs for diversification and maybe a little extra return…. not to mention a 2% dividend yield that rivals current 10-year U.S. Treasury yields.
Is the analysis too simple? Sometimes simple is best!
And yes, fundamentals do count… eventually over secular periods of time, however in my experience money flows usually trump fundamentals over the short-term.
What Am I Saying?
Readers have to consider that conditions are in place that a positive transit of EBV+4 is indeed possible and if money flows get out of hand or momentum is too strong EBV+5 could indeed be possible.
The risk here is that the investment community is way too bearish and conditions are in place that the U.S. equity markets have another EBV zone to go, in terms of valuation, to the upside.
Model Price Theory has the timing problem solved!
You hear and read this all the time on various websites, especially on bearish or perm-a-bear forecasts. Yes, the world is coming to an end because of all these very logical reasons however they can’t tell you ‘When’ this will happen.
O.K. you will face financial ruin…. but we can’t tell you when.
Model Price Theory [MPT] to the rescue!
How does MPT solve the timing issue you ask? Easy, wait for any negative transit of one of our EBV lines. Will this negative transit occur at EBV+4, EBV+5 or EBV+3? I haven’t a clue…but I will know it when I see it.
Doesn’t this solve the timing problem?
I believe so. So on a negative transit, any negative transit – which I will probably blog about – somewhere out there in the future, we will turn cautious on U.S. equities.
Again, my critics may scream “too simplistic.”
I don’t know about you but I do like “simple.”
The S&P 500 Index is now at the top of our EBV zone between EBV+3 and EBV+4. I have speculated or hypothesized on two iterations where the S&P 500 Index either crawls along just under EBV+4 until fundamentals or money flows start to turn negative – that could be years down the road – or the S&P 500 Index has a positive transit of EBV+4 and may have enough momentum to carry the index all the way to EBV+5.
Do I know for certain which scenario will occur? No, I don’t.
But I am certain any negative transit will give me the opportunity to adjust my asset allocation to a more cautious stance if and when this aforementioned negative transit has indeed occurred. And I will be ready for the widely believed financial calamity everyone seems to be forecasting.
P.S. I would be remiss not in acknowledging the anniversary of the bottom on the S&P 500 Index six years ago – on March 9, 2009 to be exact – at an index level of 666.
Not to be overly overt but I have included a screen shot of the front page of our Acker Finley website giving the performance relative to our benchmark (S&P 500 Total Return Index in CDN$) of our Acker Finley US Value 50 Fund priced in CDN dollars. Yes, we are up over 350% from March 3, 2009 to present, after all fund expenses.
Acker Finley Select US Value 50 Fund performance over the last six years. March 3, 2009 – March 4, 2015
I will never forget this bottom for as long as I live and it hardly seems possible that this event occurred six years ago – feels like yesterday.
A substantial part of this return occurred because we were fully invested at the market bottom on March 9, 2009.
For those interested, I blogged what I did differently in the market crash of 2008 that I didn’t do in my previous experienced market crashes of 1987 and 2000 on the fifth anniversary of the market bottom obviously one year ago. Of all my blogs this one remains one of the most popular.
“10 Things I Did Differently in the Crash of 2008; That I Didn’t Do in 1987 and 2000.”