Tag Archives: S&P 500 market prediction

Who do You Believe: Equity Analysts or the Market? – Reblog


I have been on hiatus from my blogging.

I have been upgrading my skills. Learning to ‘touch type’ so the words flow more freely, more genuine. I’m up to thirty words a minute and probably at the most frustrating part of this learned skill. Wanting to let the words fly on the keyboard but stopping way short by my fat fingers.

But I’m working everyday.

Also we are entering second quarter earnings season of 2014. My feeling is the US equity market is in a ‘take no prisoners’ kind of mindset. If any disappointment both on top line revenues and bottom line earnings the market reaction will be swift and judgmental. In other words…down. Even though the stock risk will be high, in my estimation, I still believe the market – S&P 500 – crawls higher to EBV+4.

In the mean time I will post a re blog of a blog I posted a year ago delineating the difference between our model price calculation and our EBV Lines illustrated on our model price charts. New individuals are joining and commenting everyday on the Model Price Facebook App and I believe this blog clearly explains the two pieces of calculated information we give to our users.

The blogging will be starting up again, now that at least I’m somewhat proficient at the keyboard and leaving behind the two finger ‘pecking’.

 

 

People new to Model Price have to weigh fundamental information given to them in the form of our lines on our model price charts.  Remember our Model Price charts gives or calculates two pieces of information for users – the first is our purple line or model price and the second is our parallel lines known as EBV lines or Economic Book Value lines.  Each product deliverable, model price and EBV lines, is independent of the other.  Sometimes these two data sets can confirm each other or offer major divergences from each other. I use both pieces of data independently but often give higher importance to our calculated EBV lines.

This blog post will discuss each product, model price and EBV lines, to give you a better or a more full understanding of the similarities or differences between the two.

Model Price (Purple Line on our Model Price Charts)

Our objective in the calculation of model price is to calculate what we believe to be fair market value of the company.  The algorithm that calculates this number is long and complicated but the most relevant piece of data in the calculation of model price is analysts “mean” earnings estimates.  For convenience sake we use estimates from of a group of published analysts from services that can be found on any popular financial news website.  (Yahoo is a popular example)

Whether people realize this fact but analysts’ earnings estimates change all the time when taken as a group mean average.  Individual analysts can change their quarterly estimates by fractions having an impact on the group “mean” estimate. Also material changes can occur during a quarterly earnings release and conference call, for example, as analysts adjust earnings when new information maybe released by company management impacting future financial results. We capture these changes on a daily basis and calculate a new model price based on the most up-to-date financial information. We maintain a database of our calculated model price and obviously use this price series to maintain our model price charts.

Probably the most interesting aspect of our model price calculation is the forward calculation of model price for the next year (long term model price chart – right chart) to give our users some perspective of the future trend of model price based, of course, on analysts’ estimates of future earnings.  We take great care to grow the balance sheet in future periods so the earnings estimates are current with the relevant balance sheet.  Obviously we cannot anticipate future corporate actions like M&A activity or common stock sales however most large cap stocks have stable capital structures that any projections of model price can be very accurate using past history as a guide.

For those of you who don’t know the job of equity analyst of Wall or Bay Street is one of the most demanding jobs in the security business. A top analyst can receive millions in compensation from their investment bank if they are the most accurate in terms of a company’s quarterly earnings estimate.  The pressure to be right about their coverage not only about the company itself but also the industry can be intense.  As a general rule of thumb, the larger the company the more analysts cover the company yielding higher quality earnings estimate data and relevance for the purposes of our calculation of model price.

This is the good news.

See my blog “Loblaw’s Deal with Shoppers Confirms our Model Price Calculation” as an example of our model price confirming fair market value (FMV) of a company.

The bad news is that equity analysts can also be wrong!

When company and industry trends are placid and predictable equity analysts are usually 99% on the mark in forecast quarterly estimates.  This makes sense.  Unfortunately when the company or industry is in turmoil the vast majority of the analyst’s freeze or hold their changes in estimates until the company comes clean or more information is available to quantify potential changes, usually in a quarterly conference call, or clearer trends manifest itself  in the industry.  These are major transition points where the stock price and the fundamentals of the company start to diverge.

These divergences – between the perceived fundamentals and actual fundamentals – is, in my opinion, where investors are the most vulnerable.

Enter Economic Book Value (EBV Lines)

Our second product deliverable is our EBV lines.  These are parallel lines that run through our model price charts.  Some of the EBV lines are coloured (green, blue, red and yellow for example) and others are grey or black.  In constructing these EBV lines we start with our green line or EBV.  As we add lines above our green line on a constant basis and we number each line in sequence (i.e. EBV+1, EBV+2…EBV+10). For EBV lines below or calculated green line we label EBV-1, EBV-2, and our last one EBV-3.

Once these EBV lines are constructed we add a simple open hi-lo-close price bar of the company’s publicly traded equity price.  We use a weekly price bar for our left hand chart – our definition of short-term view – and monthly price bars for our right hand chart.  It should be noted that these two pieces of data, EBV lines and public equity prices, interact independently of each other.  When the stock price of a company transits an EBV line, either positively or negatively, fundamental information is given to the observer of our model price chart.  A positive transit, stock price transits up through one of our EBV lines indicates fundamentals are improving for the stock in question and conversely if the stock price has a negative transit fundamentals are deteriorating.

Magically over time and experience users of model price will become convinced of the usefulness of our EBV lines. Equity prices of companies seem to use these EBV lines as support and resistance.  When transits do occur, both positive and negative, usually prognosticate major future company news that can have a major influence on the company’s future share price and direction.

See my blog “$76 Billion Reasons to Sell Gold Stocks.

These computed EBV lines can also give observers a quick reference point in terms of a company’s valuation.  When comparing a basket of equities together in indices or in the same industry an observer can quickly evaluate the valuation of the company in question.  For example, company ABC can trade above EBV+5 where as company XYZ may trade just over EBV+3 indicating a lower market valuation level for comparative purposes.  Our computed EBV lines can provide a quick reference and apples to apples comparison of individuals companies.

Back to the question, “Who do You Believe: Equity analysts or the Market?”

So you, the user of our Model Price App, get two pieces of financial information of a company that appears no where else on the internet and is not taught in any financial course at university – Model Price and EBV lines.

Users of Model Price App, a service that provides these calculations, have to weight these two pieces of information carefully.  Yes, knowing the fair market value of a company is indeed insightful when contemplating either a sale or a purchase of a particular company however analysts are the primary driver of this calculation and users should know their fallibility.  Where as our EBV lines are derived from the company’s balance sheet that in my opinion is more robust – a balance sheet has to balance after all  – and less likely manipulated by management, except in the case of fraud.

In a nutshell a lot of times, these two pieces of information – Model price and EBV lines – are confirming each other.

Here is a recent example of Yahoo having a positive transit of EBV+3 being confirmed by a positive and upward sloping model price calculation.

Yahoo Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Yahoo Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

At major transition points, in equity markets in general and company dynamics in particular, I weight our EBV lines more heavily than our model price calculation. “The Market” is usually smarter at transition points than the equity analysts following the company on a group basis.

Barrick Gold back in February 21, 2013 having a negative transit even through our model price calculation is substantially above the current selling price is a good example of the divergance between model price and our EBV lines.

Barrick Gold Corp. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Barrick Gold Corp. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

The weighting of the relevancy between model price and our EBV lines usually takes the user a short period of time and experience however in my opinion worth the time spent in terms of profitable investing.

July 2014 – Monthly S&P 500 Market Strategy Update

Ditto!

 

“Sorry what was that?” you say.

 

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

 

What else can I say but the obvious…ditto!

 

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

 

S&P 500 Index Model Price Chart

S&P 500 Index Model Price Chart

 

 

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

 

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2162) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1728) investors would be suffering losses of 13%.

 

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

 

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

 

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

 

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

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

 

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

 

As always, see what happens.”

May 2014 – Monthly S&P 500 Monthly Strategy Update

‘They’ tried to push the US equity market down, but it didn’t work.

 

We tried to have a correction in the S&P 500 in the month of April but like a beach ball submerged under water by a six year old the submerged ball keeps on floating to the surface of the water when the child’s hand is released.

 

Let’s have a look at the model price chart of the S&P 500.

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).

 

For new readers 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.

 

The US equity market, as defined by the S&P 500 Index, is in the middle of the zone between EBV+3 and EBV+4 as you can observe from our calculated model price chart. Upside to EBV+4 is 13% and downside or risk is almost 10% from the May 1st S&P 500 Index close.

 

As you can observe from our model price chart and weekly price bars the market tried to sell-off in the second week of April only to rise again in the following week. The market, again as defined by the S&P 500 Index, is very close to hitting all time highs as this blog is being written.

 

Couple of Key Positive Points

 

The month after any calendar quarter-end is always a busy time for us. Model price chart updates are being computed as fast as possible with the requisite evaluation on behalf of interested users. As April 2014 disappears in the rear view mirror I had two thoughts on this last month. One observation I would like to make is on April’s overall market trading action and the other on the general economic climate.

 

  1. The Market seems to be more Discerning and Rotational!

 

It has been a long time since the US equity markets has been rational or logical, from the vantage point of looking through the filter of our model price charts. What I liked about April’s market action is the market appeared to me more what a call “discerning”. What I mean by this is the expensive/momentum stocks heavily sold off while the true value stocks either held there own or had positive performance. In other words, investors and traders seemed to be rotating from the very expensive to the value names that in my mind are a sign of a healthy market.

 

Expensive valuation names like LinkedIn, Amazon, Tesla and other market darlings cratered. While the value names like Cisco, Intel, and Microsoft held their ground or gained slightly. This to me is a sign that money is finally staying in the market and acting somewhat rationally in that investors/traders are selling expensive stocks and seeking out value.

 

My sense and looking at long-term money flows, since the ‘Financial Crash of 2008’, was that when investors made any money or gains on their individual positions they would exit not only their positions but also the market entirely.

 

In order to have a healthy US equity market going forward we need to see money stay in the market and rotating through or finding value in stocks and the market as a whole. In my opinion we haven’t seen this discernment on behalf of money mangers in valuation in quite sometime.

 

Why, you may ask?

 

Value names are more at risk in a slow or worse a deflating economy. Cheap valuation names or companies carry more downside risk than companies that are growing double digits and exceeding analysts’ expectations. I’m NOT saying we are completely out of the woods yet, but there are healthy signs of US equity market maturity as investors are more discerning of the valuation of their stocks in their portfolios.

 

 

  1. Don’t tell the ‘Crash’ Bears, but the US has recovered all the job losses since 2007.

 

Certainly the chart of the month, if not the 2014 calendar year, is this one prepared by www.calculatedriskblog.com.

 

Chart courtesy of calculatedriskblog.com

Chart courtesy of calculatedriskblog.com

 

This chart does speak volumes. It speaks not only of the depth but also the duration of the ‘Financial Crash of 2008’ on US employment.  Well on Friday, May 2nd the US Department of Labor released employment statistics that now indicate the US has gained back all the job losses, dating back to 2007, that were lost during the last 5 and some years.  Yes, this is a good news story and a pivotal milestone has been reached.

 

Hopefully nothing like this will ever happen again and the next painful recession or economic downturn will be generations away.

 

Conclusion

 

All in all April was a good month, especially for value investors like us. Yes, we may have been close to flat, in terms of performance for the month, but for some of the growth and momentum crowd April ended up with negative rates of return not only for the month but also for the 2014 calendar year. Sometimes I have to admit market internals and economic progress is painfully slow to watch but baby steps (and I do mean little’s baby steps) are being walked in a positive direction.

 

Combining a painfully slow long–term recovery with a long and brutal winter season hasn’t impeded overall first quarter earnings that, when viewed from 40,000 feet, weren’t too bad.

 

The ‘Crash Bears’ were out in force this month when the high-flying momentum stocks started to correct in mid-month. However they were quickly silenced when the overall market quickly recovered and cash rotated to cheaper equity names. And then the economy added an exclamation point by printing a jobs number that even the ‘Crash Bears’ have to admit was a good number!

 

 

Flash – Rundown or Strategic Review of our Model Price Equity Indices Charts


After another down day in the markets, let’s have a look at our model price charts of the three major North American equity indices that maybe of interest.

 

In no particular order,

 

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).

 

No correction here.  At least not yet!

If things do get hairy south of the border, then look for downside support at EBV+2 or 13,906.  That’s only 2.6% below tonight’s close.  No big deal, right?

 

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).

 

I can hardly see any correction on this price chart, can you?  Support for this Index is back to EBV+3 or 1716.  That’s only 7% from tonight’s market close, which doesn’t sound like much but I’m sure this will shake investors’ confidence if this Index did reach support in the immediate future – leaving buyers with a great buying opportunity.  Keep in mind the closer this Index gets to EBV+3 the less risk investors will be taking in the US market in general.

 

NASDAQ 100 Stock Index (NDX)

 

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

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

 

I guess I don’t need to tell anyone that the NASDAQ stocks have been the ones that have corrected the most.  The good news, as of tonight this Index has a downside risk of only less than a percentage point before touching support at EBV+5.  Look for the NASDAQ Index to start looking for support, or better still individual NASDAQ stocks to start holding their ground in the next few days at their own support levels or the bottom of their current EBV zones.

 

Big rallies have and do occur when Index EBV support levels are reached when individual stock declines become tapered.  Buyers do become emboldened when they think the sellers have abated for whatever reason.

 

Hopefully this will give you some guidance on where we are at with this market and plan your investment or trading plans accordingly.

March 2014 – Monthly S&P 500 Market Strategy Update

Back from vacation, rested and ready to go.

Let’s start with an update on the US equity markets that never want to correct.  Ukraine and Crimea.  This market doesn’t seem to care; at least not today.

What does our Model Price chart look like?

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.

Simply stated the S&P 500 has an upside of almost 13% and a downside of 10%.  If and when the S&P 500 Index value gets closer to the top of the zone or EBV+4 we will become more defensive both in our cash position and our stock selection.

It’s been a great 5 years, in terms of performance, for US equity investments.  However bull markets do come to an end usually because of excessive valuation either in a rising interest rate environment or future weaker economic growth.  Knowing what EBV levels investors use to increase and decrease equity allocation is very important for large outperformance and compounding rates of return of any equity asset class.

This current bull market started at EBV+1 (March 9, 2009) and is probably heading for EBV+4 and higher.  Reducing your US equity exposure in your portfolio will be difficult when everybody is pocketing seemingly over-sized profits.  Unfortunately, if the past bull-bear cycles are any indicator – they are – these same individuals will lose these over-sized profits and much more when the US equity markets rollover to bearish declines.

If you think I just turned into a bear than you misread what I have written.  I am strategizing on the future in terms of US index levels – and EBV levels – and my future US asset allocation.  Our math driven EBV levels allow you to do this.  With all positive market action over the last couple of years, it’s only my intention to put a little crumb of thought into planning how to gracefully exit this current bull market with your (hopefully) oversized gains intact.

February 2014 – Monthly S&P 500 Monthly Strategy Update

This blog should be read in conjunction with my earlier blog, “In a Year of Multiple Transitions: This one is the most Important to your Financial Health!

Which camp are you in?

There are two camps of thought about this equity market.  The bearish camp, where deflation and hyperinflation are the topics of choice, and so much can go wrong in an interconnected world where financial transactions can occur with a push of a button on one’s iPhone.  The bullish camp, as I posited in an earlier blog, must take a ‘Leap of Faith’ that the economy can grow on its own without US Federal government help – both fiscally and monetarily – or said differently increasing business confidence can encourage the private sector to invest, spend and hire.

We are at a critical juncture with the US economy with everybody taking sides – bullish versus bearish views – with no middle ground in sight.

Add this uncertainty with having a US equity market that hasn’t had correction for close to 600 days and one has to conclude the inevitability of the equity markets taking a powder.

Model Price Chart of the S&P 500

As long time readers have come to expect, here is our calculated model price chart for the S&P 500 up to February 3rd, 2014.

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).

For new readers 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.

“Stuck in the Middle with You”

Remember the song by Stealers Wheel, “Stuck in the Middle With You”; well that’s where investors are finding themselves when talking about the S&P 500 in terms of Model Price Theory (MPT).

For new readers to MPT, stock and index values can trade (move) within our calculated EBV Lines without consequence.  It’s only when market values have negative or positive transits of our EBV Lines that signify changing fundamentals.  So markets can roam within EBV zones without consequence and for a period of years.

The only actionable steps users of MPT should consider as S&P 500 Index falls closer to EBV+3, allocations to equities can increase.  Market corrections are a time investors can initiate purchases of companies included on their wish list for lower prices or better still adding to already established profitable portfolio positions.

As you can observe from our model price chart (above), and after Monday’s downward action, the S&P 500 Index is less than 100 S&P points away from EBV+3 or 1646 or on a percentage basis this differential represents only 5.5%.  To have the S&P 500 back to EBV+3 or support this would be a welcomed opportunity for those who wanted to add additional exposure to US equities.

The upside is of course EBV+4 or some 18% higher than the market close last night.  The risk reward for equity investors is getting skewed in favour of rewarding investors.  This is as it should be.  As the market goes lower the more potential value accrues to the investor.

Conclusion

You can almost hear the sucking sound.  Investment dollars are being sucked out of emerging and secondary markets and heading towards the United States.  I’m sure global investors were shocked when the Canadian dollar and other peripheral currencies were trounced in January as investors fled in droves.

In times of transition, all markets go down and over a period of time strong fundamental markets will drive to new highs.  Obviously we are in the ‘all markets go down’ phase of this transition giving opportunistic investors or followers of Model Price Theory (MPT) confidence in increasing their asset allocations in favor of US equities.

Macro forces are at work; with global investment flows being the primary driver to both currency and equity markets.  This could be a confusing time for investors because company specific data, such as earnings, will be taking a back seat.  Friday morning will be interesting with the monthly US employment numbers from the Department of Labor.  Severe winter weather along with seasonality adjustments will make this number a ‘crap shot’.  Seat belts may be required for both, upside and downside action.

January 2014 – Monthly S&P 500 Market Strategy Update

Let’s contemplate the future – economically speaking!

As president and chair of the board at my local golf course some years ago I made the observation that it’s not the one or two big decisions that a general manger makes during the summer season that made the annual break even budget fall into line with the actual revenue and expenses.  It was the general manager’s daily decision making, the small and numerous decisions, that carried the day.

The same is true with our open and complex economic systems.  Hundreds and thousands of decisions are made daily by policy-makers and government officials that cumulatively could have massive impacts on economic growth for each country participating in the global economy.  And size does matter.  Favorable or unfavorable policy decisions in the United States, China, Japan and the European Union have a large impact on worldwide economic growth.  Which of these mostly secret decisions will have a positive or negative impact on economic growth, we as market observers, will never know.

As I said in earlier blogs, individual markets, especially equity markets, are about feedback.  Good economic policies provide a backdrop for positive economic results.  When the economic tide is rising this helps everybody globally.  Combining a good economic backdrop along with a company gaining market share provides a stimulus for healthy stock gains in the future.  This makes sense.

The issue I have with market punditry is the predictability of market forecasting.  Can anyone confidently predict the future when hundreds of thousands of daily decisions on economic policy that could have huge impacts on feedback mechanisms, like equity and treasury markets (interest rates), that coincide with the time frame of said prediction?  Yes, the combinations and permutations are mathematically endless.  Therefore in my mind economic and market related predictions and forecasts are useless.

So if one cannot predict the future with any accuracy, from a top down perspective how about from the bottom up?

Huh!

This is the basis for Model Price Theory (MPT).  By observing the feedback of primarily equity markets a MPT user can gain confidence on the economic road map ahead.

Want a good example of this?

Back in April of 2013, the S&P 500 had a positive transit of EBV+3.  Here is the conclusion of my blog that I wrote back in May 2, 2013.

For the month of April, 2013 the S&P 500 Index had a positive transit of EBV+3.  This is an historic occasion in our model price work and noteworthy.  The traffic light is “green” in that the risk and reward for long-term US equity investments is heavily skewed towards reward side of the ledger.  In other words, the proverbial wind is at your back when choosing quality US large cap companies.  This could be the beginning of a secular run in US large capitalized equities that could last years.  And of course this positive transit doesn’t preclude some future hiccups in terms of monetary policy, and a million other macro considerations that have yet been imagined or forecasted but the market is speaking to you and it’s saying as of today and the foreseeable future all is well!

From a bottom up perspective, looking at all the companies in the S&P 500, through the S&P Index itself, the US equity markets were providing feedback to users of Model Price Theory (MPT) that all was well, economically speaking of course.  Could I or anyone else predict this positive transit?  No.  But, of course, once there was a positive transit of EBV+3 by the S&P 500 an easy ride in terms of market gains was indeed predictable.

Don’t tell me about the past, what about the future hotshot?

As always let’s start with our 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.

Observables from the above model price chart

1.  Since our noted positive transit back in April 2013 of EBV+3, the S&P 500 Index has traded up to the middle of the zone between EBV+3 and EBV+4 with little to no volatility.  (Small price bars)

2.  Our calculated EBV+4 is 2040 as of January 2014, leaving a further 11.35% possible upside for the S&P Index from the market close on January 2, 2014.

3.  Our calculated EBV+3 is 1631, giving the US equity market a possible downside of 10.97%.

4.  What I didn’t annotate on our model price chart are our calculated EBV levels one year from when the model price chart was produced.  In other words, EBV+3 is projected to be 1800 in January of 2015 and EBV+4 is estimated to be 2252.  Even if the S&P 500 stalls and consolidates mid way through the zone, market support in terms of EBV+3 is constantly rising reflecting the growth in the balance sheets of the companies.  (An market optimist can forecast a rise in the S&P 500 over 2014 to be 23% – from the market close on January 2 of 1831 to the top of the zone in January 2014 of 2252.)

Risk levels have increased, though!

So what to make of this analysis?  To me, risk levels have increased.  As I have stated back in my May blog, when the S&P transited above EBV+3 investor risk level was low.  Why?  Because market support levels were close to where the market was trading.  As the S&P 500 gets further away from EBV+3, investor risk level increases – this should make sense.

Would I get out of the market because of this increased risk?  Of course not.  Risk as well as reward must be judged carefully when making investments.  I am always mindful where this market is relative to where in the zone the market is trading.  As the market moves upward, closer to EBV+4, the possible downside risk increases while the upside gets squeezed.  As market euphoria increases MPT users will get more cautious – counter cyclical.

Conclusion

2013 was an eventful year in terms of economic political rankling.  Budget sequestration and the US Federal government shutdown gave market bears plenty of grist for negative forecasts.  The US equity markets thought otherwise.  Broadly, the economic decisions made by US policy-makers and global leaders have had a positive feedback in terms of US equity markets increasing equity valuations across the board.  This positive signal was given back in April of 2013, as the S&P 500 transited above EBV+3.

As the US equity market drives higher, as market participants get more confident, risk and reward levels have to be adjusted by the users of Model Price.  Yes, the S&P is gaining momentum and will probably reach for the top of the zone or EBV+4 in the ensuing year however risks do rise as the S&P 500 climbs higher in the zone.

Prediction of higher equity prices is a fool’s game.  If the S&P 500 were to pull back to EBV+3 (and the Index still remaining in the zone) – an implied 10% correction – nothing would have changed in my MPT analysis except for my and your favorite stocks could hopefully be purchased at lower prices.

December 2013 – Monthly S&P 500 Market Strategy Update

Bubbles, Bubbles everywhere!

Huh?

In my almost thirty years in the financial business – it seems longer – I have been through a few market cycles.  What is inevitable is a chorus of money managers and analysts screaming ‘Bubble’ when equity markets start to recover from cyclical lows.  In most instances the people yelling ‘Bubble’ are the ones who have under-performed the market indices by a wide margin.  ‘Misery loves company’ is a popular idiom that comes to my mind when I see these people interviewed in the business press as bearish equity market strategists and investors love to hang out with each other and share the same echo chamber.  Hopefully by the end of this blog you will be scratching your head along with me when the plethora of ‘Bubble’ interviews and press stories that will be written on the spectacular returns for the S&P 500 for 2013 in the closing months of December and early January 2014.

Another item I would like to get off my chest is this whole subject of ‘Quantitative Easing’ thing.  Market experts have commented that because of ‘Quantitative Easing’ the equity prices are somehow fake or artificially high and cannot be trusted.

Really.

In our highly mathematical world of Model Price Theory (MPT) there is no evidence that I can see that links ‘Quantitative Easing’ to unjustified or artificially high equity prices.  Equity markets in general represent a complex system that can have many influences. Do I think ‘Quantitative Easing’ is a positive in the hundreds of thousands of potential agents acting upon individual equity prices?  Yes I do.  Is ‘Quantitative Easing’ wholly responsible for the levitation of equity prices?  This I cannot agree.

Equity returns over the last 5 years, since the financial crash of 2008, are largely a function of how far the US equity markets crashed in the first place.  I sense market professionals are only looking at the rates of return – that are good BTW – without consideration of where or what valuation level the market crashed in 2008.  As public policy and US Federal government found the right mixture of appropriate policy actions, including ‘Quantitative Easing’, the equity markets have returned to a ‘normal’ valuation level, in my opinion, that is commensurate with the economic activity of the US economy.

How can you call this a ‘normal’ valuation level for the S&P 500?

Listen carefully to these ‘Bubble’ talking heads in the financial press and they start talking price earnings ratios.  Here we are in the 21st century where every industry has been touched by scientific innovation and technological advancements and finance professionals are still using a simple ratio of equity price versus earnings as a guideline to evaluate equity market valuation.

Laughable!

Want a more sophisticated filter to view equity market valuation?  Try Model Price Theory (MPT).

Let’s first look at our super 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)

Before I detail what our model price chart is communicating let me tell you how it’s constructed.  First, every company in the S&P 500 has a calculated model price chart (data).  We then aggregate all companies by market capitalization, like the S&P 500 Index, on a daily basis. We then construct a time series by amalgamating the daily data over a selected period of time.  We use our calculated constant EBV lines to ensure users can track visually EBV (valuation) levels over time.  The number of calculations to do this is in the hundreds of millions.

A little more robust than the simplistic Price/Earnings ratio, don’t you think?

Observables from our chart

1.  This model price chart goes back to 1995.  Hopefully you can observe the S&P 500 Index is at the same valuation today as we were, some 19 years ago.

2.  From the valuation level of the S&P 500 in 1995, the Index almost reached EBV+6 in the early months of 2000.  (Our calculated EBV+6 for the S&P 500 Index today would be 4448 or 147% higher)

3.  After the tech ‘bubble’ crash of 2000, you can observe where the equity market bottomed in terms of the S&P 500.  Just over EBV+3.  Yes, the market bottomed – approximately – where the S&P 500 is today. (If intellectually honest the market mavens screaming ‘Bubble’ today would have been doing the same during the market lows of 2002, yes?  Probably not.)

4.  From 2002 to July 2007 the S&P 500 Index crawled along EBV+4.

5.  You can observe the waterfall decline in the S&P from July 2007 to March 9, 2009.  The S&P bottomed at EBV+1.

6.  From the market bottom of EBV+1 or March of 2009 the S&P 500 has been working its way upward with a positive transit of both EBV+2 and EBV+3.

A Closer look at our model price chart of the S&P 500

Let’s have a look at our short-term model price chart of the S&P 500

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).

Observations

1.  Back on the last week of June the S&P touched support or EBV+3 (red line).

2.  From the end of June, the S&P 500 has been working upward through 2nd and 3rd quarter earnings.  Also don’t forget the US Federal government was shut down from October 1st through to the 16th of 2013.

3.  The potential upside for the S&P 500 is EBV+4 or 2029.  This represents a 13% upside from the December 2nd close or 1800.90.

4.  The potential downside, or EBV+3 (red line) is 1622.  Representing a 10% downside, again, from the December 2nd close.

Conclusion

Do you see a ‘Bubble’ in US equities?  I know it’s hard to fathom what the ‘Bubble Heads’ see but I certainly don’t see froth in this US equity market – at least not yet.  Could the market, as defined as the S&P 500, correct to EBV+3 or our red line?  Absolutely.  Would a correction offer investors and traders a great opportunity to purchase US equities?  Again, absolutely!  Will a correction occur?  I don’t know.  Savvy investors are always looking to buy cheaper assets or for model price users equity prices closer to support or their respective EBV lines.  But my gut tells me this US equity market as measured by the S&P 500 is on a roll and momentum can carry this market at least to EBV+4 at which time we can collect our breath and see what this market and individual stocks look like at this EBV level.

See what happens.

November 2013 – Monthly S&P 500 Market Strategy Update

Can anything stop this US market?

The new Federal Reserve chair has been appointed.  The US Federal government is back to work.  The political nastiness has subsided so all Americans can focus their anger on the one website that doesn’t seem to work – www.healthcare.gov/.

We have two months to go for 2013 with seemingly no major issue that has the potential to rock negatively this ‘Energizer Bunny’ equity market.

As usual let’s have a look at the S&P 500 Model Price chart.

S&P 500 Index with weekly price bars andEBV 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.

Risk – Reward Metrics of the US Equity Market

As you can observe from the above model price chart, the S&P 500 Index closed at 1761.64 on Friday, November 1.  Our calculated EBV+3 for the month of November is 1614 that is some 8% lower than the current close.  This is your risk in the US equity markets as measured by the S&P 500.  If there was a financial shock of any kind look for a pull back to our calculated EBV (red) line.

The reward, obviously it is the top of the EBV zone, is calculated at EBV+4 or 2019 or some 15 percentage points higher than the November 1 close.  So obviously the reward is higher than the risk involved and US equities – principally large capitalized companies – remains a good deal for investors.

Equity Markets Gearing up for 2014

Markets are in an optimistic mood these days about 2014.  The International Monetary Fund (IMF) predicting growth at 1.6% for the US in 2013 is looking for 2.6% in 2014.  Also analysts are predicting 11% profit growth in American companies in 2014.  If anything should happen to these rosy forecasts then a market correction would be understandable but as it stands today the equity markets are looking forward to 2014 and maybe you should too.

October 2013 – Monthly S&P 500 Market Strategy Update

Talk about cross currents!

Syria on, Syria off, Tapering on, Tapering off and US Government shut down on….

In this seemingly binary world the only thing that doesn’t care are the US equity markets.  The word that most represents what is going on and strikes the fear of every market participant is Complacency.

As usual let’s have a look at the S&P 500 Model Price chart.

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.

You can observe from our model price chart the S&P 500 closed at 1693.87 on October 2, 2013.  EBV+3 is calculated at 1605 for the month of October.  This represents a potential gap of 5.25%.  This represents the risk in the US equity markets.  In other words the S&P 500 Index could fall 5%, fall to support (EBV+3), at anytime or not at all.

Why hasn’t the S&P 500 fallen to EBV+3 already?

Good question.  I know several clients who sold or reduced equity positions last December on the potential US Federal government shutdown only to see the US equity markets climb healthily without their participation.

So I kind of see a stand off.  Those in the equity market saying “Why Sell?” – especially those who sold last time – and those out of the equity market are saying “Why Buy?”.

This tug of war will probably continue until certainty begins to develop on the political front or the economic front.  Keep in mind we are a week or two away from third quarter earnings news – I know, third quarter already! – that will be the main driver of stocks both up and down.

Until then, enjoy the political theater (or yelling if you prefer), baseball playoffs and if you’re Canadian, an early Thanksgiving knowing that the market downside risk as gauged by where the S&P 500 Index, relative to our calculated EBV+3 (red) line, is manageable.

Yes, I guess…. Call me complacent as well!