Archive for August, 2012

Another Look At the Bear Case For the S&P 500

Friday, August 31st, 2012

Today’s comments by Fed Chairman Bernanke gave equity markets a boost, but it also caused US Treasuries and gold to rise more strongly in a run to safety.

There are important voices on both the bull side and the bear side of the US stock market predictions.

  • On the bull side, for example: Laszlo Birinyi of Birinyi Associates, and Byron Wien of Blackstone Advisory Partners, each see the S&P 500 at 1500 by 2012 year-end — up about 7%
  • On the bear side, for example: Barry Knapp of Barclays sees 1330; David Kostin of Goldman Sachs sees 1250,  and Adam Parker of Morgan Stanley sees 1167 — down about 5%, 7% and 17% respectively.
According to Bloomberg as of a week or so ago, the mean analyst year-end forecast is 1398 (today the S&P 500 closed at 1406).
We recently published a review of the 2012 forecasts made in January by analyst for 2012, and added volatility-based price probability ranges that go from 1225 to 1575 — encompassing all but the most pessimistic forecast from Morgan Stanley.

Let’s talk about the bear view a bit.

The bear view is essentially an argument that the US economy cannot escape some level of significant recessionary impact in 2013 — mostly due to lack of faith that Congress will effectively manage the tax and spending issues that relate to the “fiscal cliff” in January.

Goldman said (source: ZeroHedge): “… the market has an asymmetric risk profile and offers more downside risk than upside opportunity. Political realities and last year’s precedent suggest the potential that Congress fails to reach agreement in addressing the ‘fiscal cliff’ is greater than what most investors seem to believe …

Barclays, rather than focusing on the fiscal cliff specifically, is talking about currently declining revenue growth, declining forward earnings forecasts, and the unreasonableness of a 13% earnings increase 2013 over 2012 at this stage in the economy.  They think the stock market has gotten ahead of itself and is likely to pull back to the 1330 area.

Barclays also points out that if the election prospects appear to be going strongly toward a Republican controlled Senate and a Republican president, the stock market could celebrate that with a rise from here.  They also point out that control of Congress is probably more important than control of the White House if only one is in the cards.

What If There Is A Significant Drop In Earnings?

We looked at the last three important earnings declines to see how the stock market reacted in terms of price change and valuation multiple change.

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From an operating earnings high for Q2 1999, earnings declined 24.4% over 10 quarters by Q4 1991, then eventually equaled or exceeded the earlier high by Q4 1993, 18 quarters later.  In that case, the S&P actually rose in price as the earnings fell, going from a 12.5 P/E multiple at the earnings high to a 21.6 multiple by the earnings low, and then down to a 17.3 multiple when the earnings recouped their former high.

Multiple expansion and market price increase occurred.  We would doubt that would happen if a new earnings dip were to evolve in 2013.


From an operating earnings high for Q3 2000, earnings declined 31.6% over 6 quarters by Q4 2001, then eventually equaled or exceeded the earlier high by Q1 2004, 15 quarters later.  The S&P declined 21% (less than earnings declined) as the valuation multiple expanded from 26.2 to 29.6; and then down to 19.4 when earnings attained their prior high.


From an operating earnings high for Q2 2007, earnings declined 57.8% over 9 quarters by Q3 2009, then eventually equaled or exceeded the earlier high by Q3 2011, 17 quarters later.  The S&P declined 29.7% (much less than earnings declined) as the valuation multiple expanded from 16.4 to 26.7; and then down to 12.0 when earnings attained their prior high.


If an earnings recession occurred in 2013, it seems reasonable, based on recent history, that a 20% to 30% or greater decline could occur.

If the 2012  earnings end up at about $102, then 2013 earnings of $70 or $80 seem quite possible in a moderate fiscal cliff bump in the road — more is possible, of course, but 20% to 30% seems reasonable.  Those earnings would compare to a current mean forecast in excess of $110.

If the valuation multiple did not expand (as it did in the last three earnings recessions, and as we understand it typically does), then 12 times $70 to $80 could put the S&P 500 at 840 to 960.

However, if the valuation multiple were to expand by 3 (the lowest of the expansions during the last three earnings recessions), the 15 times $70 to $80 would put the S&P 500 at 1050 to 1200.

That leads us to believe that in the absence of some thing as nasty as the 2008-2009 earnings crash, the 1250 to 1167 predictions by Goldman and Morgan Stanley seem reasonable as most likely worst case scenarios (not maximum worst case, but most likely worst case).

The 1500 scenario by Birinyi and Wien, we presume, assumes that the Congress works something out as a muddle through, and that Europe does not collapse, but also muddles through.


Disclaimer and Disclosure:

This and every post on this blog is subject to our general disclaimer.  As of the date of this post (August 31, 2012), we have positions in SPY.

Caution Indication: US Transports Show Negative Divergence With S&P 500

Wednesday, August 29th, 2012

Rail, trucking and package delivery are among key indicators of business activity in the United States. The recent relative performance of transportation stocks and the S&P 500 suggests that stocks overall might be somewhat ahead of themselves, or perhaps set up for a correction.

  • $SPX = S&P 500 (proxies: SPY, IVV and VOO)
  • $TRAN = DJ Transports (proxies: IYT and XTN [XTN is equal weighted])
  • $DJUSRR = DJ Railroads (members CSX [CSX], Norfolk Southern [NSC], Union Pacific [UNP])
  • $DJUDTK = DJ Trucking (member J.B. Hunt [JBHT])
  • $DJUSAF = DJ Delivery services (members, Fedex [FDX] and UPS [UPS])


These three charts plot the ratio of the price level of each of several transportation indexes versus the S&P 500.

5 Years Monthly Relative

5-Year Monthly Absolute

The 5-year chart generally is outperforming the S&P 500 since the market bottom in 2009 until mid-2011, when it was basically flat with the broad index, and then under-performing in 2012.

1 Year Weekly Relative

1-Year Weekly Absolute

The 1-year chart more clearly shows the turn to negative relative performance in 2012 for  all but railroads — and they too have turn down on a relative basis recently.

3 Months Daily Relative

3-Months Daily Absolute

The 3 month chart clearly shows that over the past month, the overall transports and it railroad, trucking and delivery services components are in a down movement.  That probably as a lot to do with the flattening of the S&P 500 in the same period.

Disclaimer and Disclosure:

This and every post on this blog is subject to our general disclaimer.  As of the date of this post (August 29, 2012), we have positions in SPY and NSC.


Volatility Implied 2012 Year-End S&P 500 Price Levels

Monday, August 27th, 2012

In January of 2012, Barron’s polled many professional analysts for their 2012 S&P 500 price projections.  Some have changed their views since then, but let’s use their January forecasts as background for this discussion of volatility implied 2012 year-end price probability ranges.

Professional Forecasts (January 2012):

This is a summary of the professional 2012-12-31 forecasts as of January 2012:

As of this date, Standard and Poor’s is projecting $102 per share earnings for 2012.  That’s pretty much where the professionals were back in January, with the exceptions of Morgan Stanley, Federated Investors, and Deutsche Bank, which were high; and the exception of Credit Suisse, which was low.

The bulk of the forecasts were for the index to end 2012 between about 1350 and 1400 (with a low of 1167 and a high of 1527).  The index today is at 1410.

Let’s see what a pure volatility derived guesstimate says.  It looks to us like the math suggests a price probability range of between about 1225 and 1575, not terribly different than the range of professional forecasts 8 months ago.

Each chart below plots the price (black), the 200-day exponential moving average (tan), the 10% correction level (dashed red), the 20% bear level (solid red), the price probability range based on 6-month historical volatility (green) and the price probability range based on 1-year historical volatility (blue).

The logic is based on a normal frequency distribution of prices. Reality is more irregular than that, but this is the math that underpins options pricing, and is typically close enough.

80% Probability Based On 1-Year and 6-Month Volatility:

The statistical chance of the price being outside of the probability cone is 10% on either side — 10% higher and 10% lower.  Based on 6 months of historical volatility, the 80% probable price range is 1298 to 1534.  Based on 1 year of volatility, the 80% probable price range is 1263 to 1577.

90% Probability Based On 1-Year and 6-Month Volatility:

The statistical chance of the price being outside of the probability cone is 5% on either side — 5% higher and 5% lower.  Based on 6 months of historical volatility, the 90% probable price range is 1269 to1569.  Based on 1 year of volatility, the 90% probable price range is 1223 to 1628.

Other Relevant Price Level Considerations:

If the price were to fall to the current 200 day average, it would be 1338.  If a 10% correction was reached by year-end the price would be 1284.  A bear achieved by year-end would produce a price of 1141.

Of course, the price will do what the price will do, and important events like a wider multi-country war over Syria, going over the US fiscal cliff, and collapse in Spain would through everything into a cocked hat.

In any event, the combination of professional forecasts, mathematically-derived volatility-based projections, and chart support level indications can serve as reasonable aids to forming your own view.

Earnings forecasts and estimation of valuation multiples are important too (see our blog for historical and projected P/E multiples from Standard and Poor’s, Seeking Alpha for information about historical trends in S&P 500 sales, earnings, dividends, book value and payout ratio.

Historical and Prospective P/Es for S&P 500 Sectors

Monday, August 27th, 2012

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Historical S&P 500 Yields: Sales Yield, Earnings Yield, Dividend Yield, Book Value Yield

Monday, August 27th, 2012

Dividend yield has been the topic du jour for a few years now, but there are other yields for stocks to consider. We continue to believe that owning high quality above average yield dividend growth stocks with global footprints and dominant brands is a prudent investment, but other forms of yield should be considered at the same time.

The popular way to express valuation metrics is to divide the price by something, such as sales, or earnings or cash flow or book value; yet flipping that to divide dividends by price.  We think that is a confusing approach.

Comparing a P/E to a D/P (dividend yield) creates unnecessary mental computation challenges. We think it is better to either divide P by all dimensions (which would convert dividend yield to P/D), or to divide all dimensions by price, so everything is a yield (what you get for what you pay).

We show historical yields for sales, earnings, dividends, and book value in this article.

Sales Per Share and Sales Yield:

Sales are substantially recovered from the 2008 stock market crash, but are slightly turned down.  Sales yield (sales divided by price) is not recovered from the 2008 crash and are currently in a decline.  The decline in the sales yield is mostly the result of rising share prices.

Earnings Per Share & Earnings Yield:

Earnings are at record highs and earnings yield is well above the historical average.  The minor current earnings yield decline is the result of rising prices.

Dividends Per Share and Dividend Yield:

The quarterly dividends per share are not yet fully recovered from the 2008 crash.  They are slowly recovering.  Given that a substantial portion of the high dividend companies (the banks) stopped paying dividends during the crash and have not fully restored dividends, the overall dividend picture speaks of good health outside of finance.

The dividend yield is down substantially (by about half) from the pre-crash level, but the fact that the yield has been rising during a period of strong post-crash stock price rise is a good sign of corporate financial health.

Dividend Yield and Earnings Payout Ratio:

The dividend amount are up (charts above), the yield is up, but the payout ratio on operating earnings is about where is was pre-crash (about 30%).  That is a well covered level.  The dividend yield is greater than Treasury yields, which was previously  not seen for an extended period after 1958.

Book Value Per Share and Book Value Yield:

Book value yield is how much book value you get for each dollar you pay for a share.  Book value is well above pre-crash levels.  Book value yield is in a short-term decline in a sideways zig-zag pattern that is well above pre-crash levels.

Book value yield shot up when prices crashed in 2008, but have managed to remain flat within a zig-zag pattern since the crash, as total book value has risen rapidly.

Interpretation (assuming a muddling through economy):

  • Sales and Sales Yield: Neutral to somewhat overvalued
  • Earnings and Earnings Yield: Undervalued
  • Dividends and Dividend Yield: Neutral to undervalued
  • Book Value and Book Value Yield: Undervalued.

If the US goes into recession, or political events or non-events frighten investors, prices may adjust downward significantly, raising all of these yields. If my some miracle, the many uncertainties\ and concerns vanish, prices may adjust significantly upward, lowering all of these yields.

 S&P 500 ETFs (with links to ETF fact sheet webpages):

  • SPY (by SPDRs)
  • IVV (by iShares)
  • VOO (by Vanguard)

Traditional Valuation Metrics:

The separate fact sheet pages do not report consistent valuation metrics data.  We report the traditional format data from the SPY fact sheet here  It is the oldest and highest net asset S&P 500 ETF.

  • Price/Book: 2.14
  • Price/Earnings 1 yr forward: 13.60 (based on operating earnings)
  • 3-5 Year Earnings Growth Rate (EGR): 10.63
  • Price/Cash Flow: 14.91
  • PEG (our calculation P/E divided by EGR): 1.28
  • Dividend Yield: 1.91%

 Reasons For Doubt:

The narrative over uncertainties about global GDP growth slowing due to concerns about Europe, the US and China are well discussed.  Those concerns show themselves in the continuing reduction in earnings forecasts.  While the difference between the forecast by Standard and Poor’s for the S&P 500 earnings for 2013 versus 2012 is about 10.5% (similar to the 3-5 year growth rate published by SPDRs for SPY), that growth is on a set of reduced expectations.  These charts visually present the issue:

With earnings estimates being revised down, but companies holding or raising dividends, we continue to think long-term investors should discriminate among otherwise attractive companies by giving extra consideration to those with higher yield and long periods of consistent and rising dividend payment.

Upside and Downside Market Move Capture By International ETFs

Friday, August 24th, 2012

It is important to be aware of the tendency of stock funds to participate in an up market move or down market move.  Ideally, one would be in funds that tend to capture all or more of the move of a benchmark during an up market, and in funds that tend to capture significantly less of the move of the benchmark during a down market.

Those relative moves are called the “capture ratios”.  The table below lists the upside and downside capture ratios over 1 year, 3 years, and 5 years for the 70 international stock ETFs with at least 5 years of operating history and at least $50 million of net assets (plus SPY representing the S&P 500 for the United States).

Actionable Idea:

After evaluating capture ratios for various periods, own those ETFs with best upside capture when benchmarks turn up.  Switch to ETFs with best downside capture ratios when benchmarks turn down.

Difficulties With The Idea:

The approach is easier to describe than do, because their are more issues to consider than just the ratios in the table; and because distinguishing between corrections and bulls or bears is a subjective matter for most people, with significant whipsaw risk.

The factors present in those ETFs that caused the capture ratios in the past may not be the same ones that will cause similar capture ratios in the future.

Different historical time periods present different capture ratios for individual securities, complicating judgment about which security is likely to be a better performer in the next cycle.

At a minimum, it would be a good idea to take this data into consideration, and then think through what ought to be the basis of capture ratios in the next up or down market, and make choices (to act or do nothing) with that understanding as background.


Suitable for accounts with investment experience and active management as part of their approach or advisor mandate; and which believe that technical factors can in fact reasonably detect changes in benchmark trend direction; and when daily vigilance is possible and likely.

This approach is not suitable for those accounts that do not consider technical analysis, or that do not make daily observations of the relevant data, or that do not believe in or wish to practice tactical portfolio repositioning.

Data Description:

The benchmark for the international funds is MSCI EAFE (SPY has the S&P 500 as its benchmark).

The capture ratios for each period and each direction are color coded from red to green through yellow and shades in between to represent worst (red) and best (green).

The table is sorted according to 5-year downside capture (on the assumption that readers might be most interested in the data that covered the 2008 crash).  That 5-years also encompasses the full period so far of the European debt crisis since Greece emerged as the canary in the coal mine 3 years ago.

The EAFE index ETF (EFA) is shown in bold text with cells outlined.  As it should be, EFA is in the middle of the list, because it is supposed to have unity with the benchmark, except for tracking error and fund expense drag.

ETFs that are close to the EFA position in the table with yellowish shading, have tended to perform about the same as EFA.  The ETFs near the top and bottom of the table (and shaded in the darkest red or green) have performance that is significantly different from that of EFA based on the 5-year downside capture sort order.

Standout ETFs:

The six ETFs that are located +/- three positions either side of EFA are:

  • EZA: iShares MSCI South Africa
  • DOL: Wisdom Tree International LargeCap Dividend
  • GWL: SPDR S&P World ex-US
  • DWM: WisdomTree DEFA
  • DIM: WisdomTree International MidCap Dividend
  • SPY: SPDR S&P 500

The five ETFs with the least participation in the 5-year downside of MSCI EAFE are:

  • DFJ: WisdomTree Japan SmallCap Dividend
  • EWM: iShares MSCI Malaysia
  • JSC: SPDR Russell/Nomura SmallCap Japan
  • DXJ: WisdomTree Japan Hedged Equity
  • EWJ: iShares MSCI Japan

The five ETFs with the greatest downside participation (actually a multiple of the downside of the benchmark) are:

  • RSX: Market Vectors Russia
  • EWO: iShares MSCI Austria Investable Market
  • EWI: iShares MSCI Italy
  • GUR: SPDR S&P Emerging Europe
  • EWP: iShares S&P Spain