Tag Archives: S&P 500 market prediction

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 – Monthly S&P 500 Market Strategy Update

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

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

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

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

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

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

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

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

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

 

Top of Zone EBV+4

 

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

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

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

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

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

 

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

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

But one has to ask the most obvious of questions.

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

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

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

The answer is a resounding yes!

What was the difference?

The U.S. dollar!

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

U.S. Dollar Index (DXY)

U.S. Dollar Index (DXY)

 

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

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

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

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

Is the analysis too simple? Sometimes simple is best!

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

What Am I Saying?

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

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

Model Price Theory has the timing problem solved!

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

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

Model Price Theory [MPT] to the rescue!

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

Doesn’t this solve the timing problem?

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

Again, my critics may scream “too simplistic.”

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

Conclusion

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

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

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

 

 

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

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

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

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

 

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

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

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

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

 

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 500 Market Strategy Update

Sometimes simple is best.

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

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

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

“Is the tide coming in or out?”

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

Huh?

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

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

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

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

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

And I like simple.

You?

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

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

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

 

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

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2217) this would represent a gain of some 8.2%. If the market corrected back to EBV+3 (1773) investors would be suffering losses of almost 14%.

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

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

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

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

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

 

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

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

Could this happen again?

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

Is EBV+4 exceedingly expensive in terms of valuation?

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

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

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

Conclusion

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

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

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

December 2014, S&P 500 Market Strategy Update

I guess everyone sees what is going on in the global equity world.

The US equity market, by all consensus including everyone at a cocktail party I went to last Saturday night, is the global equity market of choice. Yes, of course everyone is bullish and I’m sure investors are shifting portfolio allocations as I write this.

And yes, this is making me extremely uneasy.

We calculate a six-year total rate of return on our US equity mutual fund, Acker Finley US Value 50, on the front screen of our website, here. And on selected days we are up 250% over a rolling six-year period on recent days the market closes, handsomely outperforming our benchmark, the S&P 500 Total Return Index in Canadian dollars. Can we do any better? I don’t think so.

In other words, the fundamentals of the US economy, especially with falling energy costs and ever increasing US dollar, haven’t been this good for a long time. As my cocktail banter shows people see what’s going on here. Yes, the U.S. equity market has figured out this good news a while ago and has accordingly priced these improving fundamentals with ever increasing share price valuations while the market bears were yelling “Bubble!” And people being people they are lining up for the returns that have already happened!

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

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

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

 

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

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2206) this would represent a gain of some 7%. If the market corrected back to EBV+3 (1764) investors would be suffering losses of almost 14%.

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

Squeezing Up to the Top of EBV+4

The next few quarters are usually very strong, seasonally, for US equity share prices. And I do expect the S&P 500 Index to squeeze up to EBV+4 giving equity participants more equity gains over the next little while. This shouldn’t be hard to imagine as worldwide investors (especially Japanese and European investors) evaluate rates of return on global assets and seeing their portfolio equity returns in US dollars will simply say to their respective financial advisors, “Gimme more of that!”

Risk versus Return

As I have said previously, the S&P 500 Index can float between EBV+3 and EBV+4 without consequence according to Model Price Theory [MPT]. However there is a big difference in the risk/reward scenarios if the Index is closer to EBV+3 than EBV+4. I would caution U.S. equity investors’ that as the S&P 500 Index pushes closer to EBV+4 the more investment risk investors are taking with their US holdings.

Conclusion

Everyone now sees the US equity market as the market of choice, in terms of rates of return, for the next few quarters at least. At the same time as the S&P 500 Index pushes towards EBV+4, investors are taking on an increasing amount of risk with limited upside return, assuming EBV+4 is the maximum valuation level this market will achieve (and this will be a future blog post for sure!).

For investors who have been in the US market since the market bottom of March 6, 2009, it has been one hell of a ride. (From EBV+1 to a little under EBV+4, so far!) Unfortunately new investors hoping to capture any of these huge index gains of the past will be sadly disappointed. I’m not predicting doom and gloom here but just pointing out the obvious…returns will be lower with a much higher risk levels for those first timers eagerly throwing their capital in US equities at this time.

November 2014, Monthly S&P 500 Market Strategy Update

Looking at what the US market did for the month of October, I reminded of what I would call a “Crazy Ivan”.

Yes, this is reference to the infamous movie, “The Hunt For Red October” where we were introduced to Russian submarine captains making aggressive maneuvers, turns, on a random basis to see if a US submarine was shadowing the aforementioned Russian sub.

Have a look at our model price chart below and see if you don’t agree.

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 (2199) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1759) 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, respectfully.

IS THERE ANY MEANING TO OCTOBER’S MARKET ACTION?

As I have said previously, any and all index moves within ‘the zone’ – between EBV Levels – is without consequence. What we try to do is measure risk levels intra-zone. In other words when the index level or stock price recedes to the lower EBV Line then investors are taking lower risk than if the index level or stock price closes in at the top or upper EBV Line. This should make some sense.

Transits are another matter. Any transit, index level or stock price piercing an EBV Level, is giving model price users information that the fundamentals are changing depending on the transit. If there is a positive transit, the index level or stock price increases through the upper EBV level, this signifies a positive change in fundamentals is occurring. The opposite is true if negative transits occur.

So as you can see from the above model price chart the US market as represented by the S&P 500 Index sold off in the first two and a half weeks of October, only to rebound to new highs in the second half of the month. This ‘high jinx’ in market action was certainly noteworthy however since all this action took place intra-zone no fundamental economic conclusions can be interpreted via Model Price Theory [MPT].

CONCLUSION

The market was certainly more volatile in the month of October than we have seen in awhile. However according to Model Price Theory [MPT] this volatility is par for the course because all the market action took place intra-zone – between EBV+3 and EBV+4.

Until evidence to the contrary, a negative transit of EBV+3, the bull market in US equities is still intact. So the US market did a “Crazy Ivan”, making some investors nervous and of course giving the permabears something to talk about in the financial press. But fundamentally and according to Model Price nothing has changed by October’s market action.

‘King’ U.S. Dollar Returning!

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

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

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

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

Really!

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

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

Want an example?

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

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

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

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

Why mention this?

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

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

Am I guessing here?

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

U.S. Dollar Index

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

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

Source: Wall Street Journal

Source: Wall Street Journal

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

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

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

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

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

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

 

Long-term Model Price Chart

 

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

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

 

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

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

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

 

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

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

 

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

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

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

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

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

Financials

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

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

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

 

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

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

Energy

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

 

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

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

 

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

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

Telecoms

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

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

 

Hmm…. No surprise here.

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

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

Utilities

Now this was a surprise to me.

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

 

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

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

 

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

Conclusion

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

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

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

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

September 2014 – Monthly S&P 500 Market Strategy Update

There are no ‘Cheerleaders!’

If you want to put your finger on ‘what’s wrong’ with this market it’s that no one wants to cheerlead this thing. In the run up to the market crashes of 1987, 2000 and 2007 equities were the only game in town with the investment public along with institutional investors shaking pom-poms with excitement. Everyone back then, and I do mean everyone was invested with both feet with the financial press leading the charge.

Comparatively today as the S&P 500 Index hits all-time highs, on a daily basis, nobody seems to care. (See CNBC’s latest ratings courtesy of ZeroHedge here) Better still who or what group of people or institutions can be seen as leading the charge to invest in equities. Giving everybody the all-clear signal that it’s OK to be invested.

In the past bull markets we had Abby Joseph Cohen, George Soros and even Alan Greenspan for goodness sake! Industry leaders publicly announcing bullish price targets and trumpeting America’s inherit abilities and strength. Who and where are these people today? Anybody?

Or is having no ‘Cheerleaders’ the single biggest positive for the US equity market going forward?

Confusing…. maybe?

And the institutions and retail investors who I talk to everyday – who are invested – seem to have the confidence only to have one foot in this market. It seems to me that for any reason if something were to happen – from a myriad of Global hot issues – or if a correction were to start tomorrow seemingly everyone would hit the sell button immediately.

Talk about ‘knife edged’ investing!

However look at our model price chart for the S&P 500 – below. It looks tranquil and upward sloping. Remember our index price bars show weekly movement of the S&P 500 and what does it indicate? Index price gains with no intra weekly price volatility.

In other words a perfect market to ‘Cheerlead’!

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

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

 

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

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2190) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1751) investors would be suffering losses of almost 13%.

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

Two Ways of Making Gains in the Market

Model Price charts can help investors differentiate between the two ways of making gains in the equity market. As the index price value increases and moves up in the zone between EBV levels, the valuation of the overall market is increasing. In other words the market, collective buyers and sellers at the margin are willing to pay more in price terms for the earnings generated by the companies included in the index or in this case the S&P 500. As the S&P 500 Index crawls to EBV+4 investors are benefiting from an ever-increasing valuation.

The second way of making gains is the growth of the book values of the companies included in the index. Companies over time usually increase their book value as excess earnings are accumulated on their balance sheet. We capture this growth by calculation of our EBV lines. If you observe upward sloping EBV Lines the collective companies in the S&P 500 Index are increasing their book value or net worth over time. Over long periods of time companies usually increase their book value after dividends are paid and stock buybacks are deducted from capital of about 4 or 5 percent compounded.

Why do I mention this?

Over the last soon to be six years, from the market bottom of March 9, 2009, investors have been benefiting from both increased valuation – from EBV+1 to over EBV+3 – and growth in book value of the underlying companies in the index. The past returns have been phenomenal to say the least…in the mid-twenty percent range compounded.

This however cannot last!

If you assume the S&P 500 Index goes to EBV+4 and stays there for a prolonged period – my most likely assumption like the period between 2002 to July 2007 (See long-term model price chart below) – the ever- increasing valuation portion of investors return will stop. Future stock returns will have to rely on the growth of the collective book value or the growth of our EBV Lines. So for instance, say the S&P 500 Index goes to the top of the zone or EBV+4 (2190). We calculate the value of EBV+4 in September 2015 to be 2420. This implies a return of 10.5% for the Index over the year. Which is good, don’t get me wrong, but not as good as the past 5 and a half years.

Long-term model price chart of the S&P 500 Index

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

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

 

Am I adjusting everyone’s expectations… Yup!

Could there be other possibilities? Yes, countless including a market correction back to EBV+3, which is always a risk.

Conclusion

The great thing about Model Price Theory [MPT] are the ‘What if’ scenarios investors can see in a graphical format that makes mathematical sense. And from these ‘What if’ scenarios investors can position their portfolios to reflect market risk and reward.

US market gains over the last 5 years have been great. However, mathematically speaking, the US markets are running “out of headroom” and lower market returns are inevitable as ever increasing valuation is unlikely to continue.

This is not the end of the world. This is just a comment on the general index itself. For those who trade individual stocks – stock pickers – this future period of time, if my most likely scenario pans out, can represent a great opportunity to significantly outperform if you or your clients are comparing yourself to the S&P 500 Index as we did using MPT during 2002 to July 2007 period.

Yes, always a bright side when using Model Price Theory [MPT].

As always see what happens.

August 2014 – Monthly S&P 500 Market Strategy Update

Ukraine seems to be getting worse with pro-Russian rebels downing Malaysia Airlines flight MH17 over Eastern Ukraine. Israel decides to send in troops to Gaza after rockets have been fired from Gaza into Israeli broader settlements. The meanest and the most feared terrorist group in the world today, ISIS, seems to be accumulating and consolidating land and power in central Iraq prompting President Obama to send military observers back into Iraq.

Yes, it was a busy July for world affairs (and US Secretary of State) but the U.S. equities markets barely noticed.

But then Argentina defaulted on their sovereign debt during the last week of July sending the U.S. markets for a much-publicized down day, erasing the annual accumulated gains for the Dow Jones Industrials and shaved half the yearly gains in the S&P 500.

At least the U.S. financial markets noticed something!

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

 

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 (2176) this would represent a gain of some 12%. If the market corrected back to EBV+3 (1740) investors would be suffering losses of 10%.

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 – of an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

Can the S&P 500 move down to EBV+3?

Absolutely!

Would it mean anything?

Nope!

Can the S&P500 make new annual highs?

Absolutely!

Yup, the higher the S&P 500 Index value or price is from our calculated EBV+3 (red line) the more risk, and conversely less reward, investors are taking on their U.S. investments.

The world can be a complicated place. The global news media along with the Internet use a loudspeaker on any and all news. The din can be deafening and disorientating. But our model price charts have a calming affect if often used. It sooths me and puts everything in perspective.

Have I found anything in the financial information world to do the same thing?

Nope!

But I’ve only got 30 years in the investment and finance business; maybe I haven’t found it yet?