Four months ago we presented a share price model for Bank of America (BAC) and predicted its share falling below zero (an important step to bankruptcy). Seeking Alpha published two years ago our academic model of bankruptcy which foresaw Lehman Brothers, AIG, Freddie and Fanny, Citigroup, CIT, and some others. Some of these financial institutions were bailed out, but this also suggests their negative share prices. Therefore, it's very important to track the BofA price in order to see early signals of sinking below zero.
Our model for BofA has a history of three years and is based on the decomposition of the price into a weighted sum of two consumer price components, a linear time trend and a constant. The background idea is a simplistic one: there is a potential trade-off between a given share price and goods and services the company produces and/or provides. For example, the energy consumer price does influence the price of energy companies. It should be taken into account that the defining consumer price (or relevant CPI) has to be related to some independent and dynamic reference, which can also be a consumer price index. A higher relative growth of the defining CPI should be manifested in a higher pricing power for the company.
For the BAC model, all coefficients, time lags and CPIs were estimated by the least squares as applied to the model error. Here we revisit the model using new data through February 2011. The newly estimated model differs from the preliminary one due to strict constraints on time lags and new data. In October 2011, the best-fit two component model for BAC(t) was as follows:
BAC(t)= -2.35OHF(t) + 1.19H(t) + 1.97(t-1990) + 165.79
where OHF is the consumer price index of other food at home and H(t) is the index of housing, both having notime lag behind the price (see Figure 1 for the evolution of the CPIs between 2002 and 2012).
In December 2011, the best model changed a bit and was the following:
BAC(t)= -2.30OHF(t) + 1.12H(t) + 2.17(t-1990) + 167.83
In February 2012, we also observed a slight change in coeffcients and no change in time lags:
BAC(t)= -2.27OHF(t) + 1.06H(t) + 2.38(t-1990) + 170.38, sterr=$3.08.
Both CPIs are available only for January 2012, and thus we actually have a one month lead by both CPIs. We are going to update the model in a week when the BLS estimates for both CPIs are available.
Figure 2 depicts the observed and predicted prices and indicates that the market overvalues the share, i.e. the share is above the predicted level. The deviation from the predicted level is also clear from Figure 3 where the model residual is displayed. Despite a small increase in the predicted price in January/February 20122, we still think that Bank of America is under the pressure of a negative stock price correction. Such a correction could bring its BAC share below $5 per share in the near future. Lehman Brothers, Citigroup (C), and other banks all had the predicted price below zero several months before bankruptcy.
Figure 1. The evolution of the defining consumer price indices.
Figure 2. Observed and predicted BAC share prices.
Figure 3. The model residual.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.