S&P 500 Is Fully Valued

Nov. 15 2010 - 5:08 pm | 65 views | 0 recommendations |

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The risk/reward of the entire S&P 500 gets my “neu-tral” rat-ing.? My recently pub-lished Index Bench-mark report on the S&P 500 offers unique insights into the under-ly-ing prof-itabil-ity and val-u-a-tion of all the com-pa-nies com-prised by this index. It also offers bench-marks for investors con-sid-er-ing buy-ing ETFs or index funds based on the S&P 500 and for com-par-ing indi-vid-ual stocks to the index.

Our analy-sis of the index is based on the market-weighted aggre-ga-tion of data from our com-pany mod-els for the 481 com-pa-nies we cover in the S&P 500. Below is an overview of the five fac-tors that drive our Over-all Risk/Reward Rat-ing of Dan-ger-ous for this?index.

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1. Qual-ity of Earnings
   • Eco-nomic ver-sus reported earn-ings – Attractive/Positive Eco-nomic Earnings
   • Quin-tile Rank-ing for return on invested cap-i-tal (ROIC) – Very Attractive/1^st (best) Quintile
2. Val-u-a-tion
   • Free Cash Flow Yield – Attrac-tive at?3.3%
   • Price-to-economic book value – Attrac-tive at?1.3
   • Growth Appre-ci-a-tion Period – Dan-ger-ous at 20?years

Notably, Apple (AAPL) and Microsoft’s (MSFT) large mar-ket caps and extra-or-di-nar-ily high ROICs have a major impact on the market-weighted ROIC of the S&P 500. AAPL has an ROIC of 190.2% and is 2.6% of the S&P 500’s mar-ket value, rep-re-sent-ing 5% of the S&P 500’s ROIC. The next largest impact is from MSFT with an ROIC of 61.6% and as 2.1% of the S&P 500, it makes up 1.3% of the S&P 500’s ROIC. With-out AAPL and MSFT, the S&P 500’s market-weighted ROIC would fall from 17.4% to 11.1%. Click here for our report on MSFT and here for our report on AAPL.

Def-i-n-i-tions of the five fac-tors that drive our Risk Reward Rat-ings are?below:

1. Qual-ity of Earnings
2. Val-u-a-tion
   • Free Cash Flow Yield –? mea-sures the market-weighted aver-age of the free cash flow divided by enter-prise value for the com-pa-nies we cover in each?index
   • Price-to-economic book value –? mea-sures the market-weighted aver-age of stock price divided by the eco-nomic book value of the com-pa-nies we cover in each?index
   • Growth Appre-ci-a-tion Period – mea-sures the market-weighted aver-age of the market-implied growth appre-ci-a-tion period for the com-pa-nies we cover in each?index

Note that the indi-vid-ual com-pany mod-els used to per-form this analy-sis incor-po-rate key data from finan-cial foot-notes and the management’s discussion and analysis to reverse account-ing dis-tor-tion and pro-vide investors with the true eco-nomic earn-ings of businesses.

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Federal Reserve Subverts Fiscal Responsibility With Cash Creation Machines Fully Cranked

Quantitative easing removes urgency from austerity moves by Congress

So, this is what life after “QE2” looks like:

• Record gold prices
• Stocks back at pre-Lehman levels
• A dollar cruising toward its 2008 lows.

Everything is rallying in terms of depreciating dollars. Mission accomplished. Ben Bernanke needs George W. Bush’s ol’ “shock and awe” flak jacket.

In case mainstream media coverage made you glaze over, here’s the quick and dirty of the Federal Reserve’s fateful decision:

• The Fed will buy $600 billion in Treasuries over the next 8 months
• The mortgage securities the Fed bought during QE1 now reaching maturity will continue to be rolled over into Treasuries, as they have been since August. That’s another $275 billion, give or take
• There was also the caveat that more of this could be in the works if unemployment stays high and inflation (as defined by core CPI) stays low.

If the federal budget deficit is supposed to run $1.2 trillion during fiscal 2011 (that’s the consensus guess) and the Fed will purchase $875 billion in Treasuries over the next eight months (that’s two-thirds of a year)?then we quickly see the Fed plans to monetize all of all the debt that Treasury plans to spit out from now through the middle of next year and then some.

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This is yet another reason we don’t expect the House Republicans to convert to the gospel of fiscal responsibility any more than they did last time they were in the majority: They can indulge in demon spending unto oblivion and the Fed will have their back.

“If this were Greece or Ireland,” Bill Bonner wrote yesterday before the announcement, “the government would be forced to cut back. With quantitative easing ready, there is no need to face the music. If bond buyers will not finance America’s trip to bankruptcy, the Fed will provide as much brand-spanking-new money as necessary.”

The main difference between QE2 and its predecessor is this: The bulk of the junk the Fed put on its balance sheet during QE1 was mortgage securities, with about $300 billion of Treasuries thrown in for good measure. Now it’s all Treasuries, all the time.?Most of those Treasuries are of medium-term duration: very few 30-year bonds are in the mix. Thus, the yield on the long bond rocketed past 4% yesterday. It sits at 4.05% as we write.

Still, what’s really notable about QE2 is the form it did not take. In August, former Fed vice chair Alan Blinder wrote an Op-Ed in The Wall Street Journal. He tossed out a number of suggestions for QE2 that, for better or worse, would actually goose the economy and not just shore up the banks’ balance sheets:

• The Fed could buy assets beyond the realm of Treasuries and mortgage securities. It could buy corporate bonds, small business loans, or credit card receivables
• The Fed could stop paying interest on excess reserves to member banks. And if that didn’t encourage them to make more loans…
• The Fed could start charging the banks interest to stash their excess reserves.

Yesterday, the Fed chose “none of the above.”

It didn’t even take up Blinder on his suggestion to adopt new language hinting at an even-longer lasting commitment to near-zero rates. We just got the same old blather about “exceptionally low” rates “for an extended period.”

“Today,” Fed chief Ben Bernanke wrote in Thursday’s Washington Post by way of explaining himself, “most measures of underlying inflation are running somewhat below 2%, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run.”

Of course, that “underlying” inflation level does not take into account your need to eat, or heat your home or drive to work. It’s only going to get worse. Your neighborhood grocer is seeing his costs rising. “The big challenge,” says the CEO of a California grocery chain to The Wall Street Journal, “will be how much can we swallow and how much can we pass along?”

He’s holding out as long as he can, but skimping on tires for your delivery trucks (seriously, that’s one of his cost-cutting measures) only gets you so far.

Yesterday, we discussed rising food, gold and commodities costs in the context of the Fed decision during this interview with Financial Survival Radio. Have a listen here:

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