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Denis Ouellet, CFA
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Denis Ouellet has been involved in the Financial sector since 1975. Now retired, he is a part-time blogger. Denis has been analyst and head of research for a brokerage company, equity manager for various investment organizations (pension, mutual and hedge funds), head of global equity... More
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  • Tapering...Equities

    This bull is getting old.

    From The Short Side Of Long:

    (click to enlarge)

    (click to enlarge)

    The old bull in me is tiring. Time to taper…equities.

    Hmmm, I hear you, yes, you may be right, the Fed is taking care of us this time with all this financial heroin. And, yes, Super Mario will do whatever it takes and Abenomics are rewriting economic Japanese history.

    Plus, the U.S. economy is clearly reaccelerating, inflation is minimal, we're about to get Janet's "new and improved" forward guidance, the GOP finally learned its lesson and President Obama's golf game is improving by the day.

    Blue skies forever!

    I am only playing the odds here, not really knowing what markets will actually do in 2014. Honestly, that's all one can do, no?

    1. Ok, let's be objective here: we are into the fourth longest bull market since the Great Depression. The only three bulls that lasted longer ended in a speculative frenzy that eventually led to a catastrophe for their riders.
    2. The only thing blue skies tell me is that it would be nice going out, walking, golfing, fishing, hiking…Investment wise, blue skies are no reason to buy, or sell. If anything, if the skies are so blue, then everybody must feel great. The contrarian in me does not really like that.
    3. Trying to find a positive narrative, I looked at each previous market peak and I could not find any combination of GDP, inflation or profit trends that could signal anything in a consistent manner. Equities have peaked in any kind of trends, positive, negative or flat.

    1. The only consistency is the Rule of 20 valuation, currently at 19.7, when the average at the 16 previous market peaks was 21.7. Excluding the two internet bubble peak readings of 1998 (27.1) and 1998 (27.1), the average is 20.7 and the median 21.5. Charts of the actual P/E on trailing EPS and of the Shiller P/E at market peaks are provided below for those who care.

    Not a bear, but an old bull that feels the need to be careful for a while. Let's see how Q4 earnings stand and what kind of guidance we get. Let's see how corporate inventories finished the year. Let's see how inflation behaves and how interest rates trend.

    (click to enlarge)

    Better be safe than sorry!

    Jan 16 12:44 PM | Link | Comment!
  • North American Banks Ranking (Sept. 2013)

    North American banks market caps rose 7.1% since my last ranking on March 2013, in line with the S&P 500 Index (+7.6%) during the same period. U.S. banks gained 10.3% while Canadian banks advanced only 1.4%. Over the last 12 months, U.S. banks are up 23.2% while Canadian banks edged up only 3.5%. Meanwhile, the S&P 500 Index rose 13.3%.

    U.S. money center banks did particularly well since September 2012: BAC (+55%), MS (+48%), C (+44%), GS (+29%), and JPM (+26%) all gained more than 25%. Among regional banks, only KEY made money-center type gains with a 34% jump. Other regionals were mixed: WFC (+19%), FITB (+19%), STI (+13.5%) USB (+6%).

    WFC regained its top rank on market cap which it had lost to JPM last March.

    (click to enlarge)

    Canadian banks continue to dominate on Price to Book Values but U.S. money centers closed some of the huge gap during the last 12 months. Five of the 11 U.S. banks ranked here still trade below book value. BAC continues to trade at the lowest P/BV at 0.7x.

    (click to enlarge)

    Canadian banks also dominate on Price to Tangible BV. Only two U.S. banks still trade below TBV.

    (click to enlarge)

    Price to Book valuation must always be analyzed against return on book to have some meaning. Five of the six Canadian banks earn a ROE (2013e) of more than 15% (BMO at 14.8%) with an average of 17.9% (17.6% last March). The U.S. banks' average expected ROE is 9.7% (9.4% last March). Excluding USB (15.7%) , the remaining 10 U.S. banks are expected to earn a ROE of 9.1% (8.8% last March), nearly half the return enjoyed by Canadian banks.

    (click to enlarge)

    One of the better ways to evaluate bank stocks is to correlate ROE with P/BV. The chart below plots the 17 North American banks surveyed on that score. For example, even though BAC looks cheap on its P/BV of 0.7x, its low current ROE justifies its low valuation. Contrary to September 2012, BAC is not undervalued relative to its peers on the basis of expected 2013 ROEs.

    (click to enlarge)

    JPM has become the big outlier. Its stock rose only 3.3% since March while both BV (+2.5%) and expected ROE (10.4% to 11.2%) rose. FITB stock rose 15.5% since March but a 10% gain in BV and a rise in its expected ROE from 10.8% to 12.1% have made the stock pretty cheap relative to its peers. Here are the March 2013 and the September 2012 charts for comparison:

    March 2013(click to enlarge)

    September 2012(click to enlarge)

    The chart below helps assess the P/BV vs ROE relationship. Dividing the expected ROE into the P/BV ratio, we get "the price of growth" in the form of the number of units of BV for each 1% of ROE.

    (click to enlarge)

    Six American banks lead the pack, up from 3 in September 2012 and none in August 2011. BAC is now the most expensive bank on that score. It was the second least expensive bank on year ago. During that period, its stock price rose 55% while its expected ROE declined from 6.7% to 4.9% (a 27% deterioration) on an unchanged BV (its expected ROE for 2014 is 6.7%).

    By comparison, C, which was the least expensive stock in September 2012 is now the 6th least expensive stock. Even though its stock rose 44%, its expected ROE only declined from 8.0% to 7.6% (5% deterioration).

    The two cheapest stocks by this measure are now FITB and JPM. During the last year, FITB rose 19% but its BV gained 15% and its expected ROE advanced 23%. For its part, JPM stock rose 26% while its BV gained 8.5% and its ROE advanced 6%.

    By country, investors are now paying 0.11 units of BV for each 1% of ROE for both Canadian and U.S. banks. For the U.S. banks, that ratio was 0.105 last March and 0.09 in September 2012. In March 2010, the ratios were 0.11 and 0.14 respectively, the U.S. banks then trading at a 27% premium.

    All previous rankings going back to May 2009 can be seen here.

    Disclosure: I am long JPM, BMO, CM, TD.

    Tags: JPM, C, BAC, MS, FITB, GS, WFC, USB, STI, BBT, KEY, RY, CM, BMO, TD, BNS, Banks
    Sep 06 2:34 PM | Link | Comment!

    From the March 2009 market trough to the end of 2012, the S&P 500 Index has appreciated 114%. Perhaps just a coincidence but, meanwhile, trailing earnings have grown 116%. Yes Virginia, earnings matter!

    However, as the chart below reveals (the chart is borrowed from ISI with my annotations in red), the various Fed QE programs have created much volatility within a profit-led bull market:(click to enlarge)

    After the termination of QE1, the S&P 500 dropped 17% until the Rule of 20 P/E (black line on chart) reached 15.4 (15.0 is historically low); after QE2, it dropped 19% (Rule of 20 P/E of 16.3) and after Operation Twist, it lost 9% (Rule of 20 P/E of 15.1) until QE3 expectations lifted stocks again. At the recent high of 1691, the Rule of 20 P/E was 17.2. If fear reaches the same low points, the downside for U.S equities is 5-15% (1485-1595), or 0-10% from yesterday's close of 1594. Interestingly, the 100 day moving average is 1578 and the 200 day m.a. is 1506.

    (click to enlarge)

    Equities are admittedly not in the dangerously expensive zone and another shift in sentiment can occur anytime.

    The problem is that unlike in 2010, 2011 and 2012, S&P 500 earnings have stopped rising. As I have warned several times this year, the earnings tail wind has disappeared, leaving equities at the mercy of currents. In the absence of any favourable political or economic currents, hugely strong monetary currents have helped steer equities up.

    The Fed just warned that these will reverse as soon as the economic currents strengthen. But investors know that the economic currents can't realistically reach the velocity of monetary currents. They have thus become wary of the announced crosscurrents and, understandably, are bringing some of their exposed fleets back in a safer harbour.

    I still see no reliable sign that the U.S. economy is about to accelerate and I disagree with the Fed when it says that the risks to the economy are diminishing. Perversely, that might be read bullishly since it would extend QE3 well into 2014. Realistically however, corporate earnings may not be able to hold much longer in a 1-2% GDP growth environment, especially if inflation remains so low. This chart from Ed Yardeni supports cautiousness on this:(click to enlarge)

    With inflation at 1.4% and trailing earnings of $98.35, the Rule of 20 says fair value is 1829 on the S&P 500 Index (20 minus 1.4, times 98.75). The current 10% downside risk pales a little against the 15% upside to fair value. However, the environment remains such that it seems highly unlikely that investors will overcome the numerous uncertainties floating around and pay fair value for equities any time soon. I would rather wait to see how Q2 earnings come out. When sailing in strong crosscurrents, it is better to have a good, sustained tail wind. There is no such support now.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Jun 21 10:15 AM | Link | Comment!
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