Global
Equity
Research
Deutsche Banc Alex. Brown
Global
Strategy
August 13, 2001
Asset Valuation & Allocation Models
Dr. Edward Yardeni
Chief Investment Strategist
(+1) 212 469 5715
[email protected]
Amalia F. Quintana
Equity Strategy Analyst
(+1) 212 469 5713
[email protected]
Deutsche Bank
- Introduction I. Fed’s Stock Valuation Model
How can we judge whether stock prices are too high, too low, or just right? The purpose of
this weekly report is to track a stock valuation model that attempts to answer this question.
While the model is very simple, it has been quite accurate and can also be used as a stocksversus-bonds asset allocation tool. I started to study the model in 1997, after reading that the
folks at the Federal Reserve have been using it. If it is good enough for them, it’s good
enough for me. I dubbed it the Fed’s Stock Valuation Model (FSVM), though no one at the
Fed ever officially endorsed it.
On December 5, 1996, Alan Greenspan, Chairman of the Federal Reserve Board, famously
worried out loud for the first time about “irrational exuberance” in the stock market. He
didn’t actually say that stock prices were too high. Rather he asked the question: “But how
do we know when irrational exuberance has unduly escalated asset values, which then
become subject to unexpected and prolonged contractions….”1 He did it again on February
26, 1997.2 He probably instructed his staff to devise a stock market valuation model to help
him evaluate the extent of the market’s exuberance. Apparently, they did so and it was made
public, though buried, in the Fed’s Monetary Policy Report to the Congress, which
accompanied Mr. Greenspan’s Humphrey-Hawkins testimony on July 22, 1997.3
The Fed model was summed up in one paragraph and one chart on page 24 of the 25-page
document (see following table). The chart shows a strong correlation between the S&P 500
forward earnings yield (FEY)—i.e., the ratio of expected operating earnings (E) to the
price index for the S&P 500 companies (P), using 12-month-ahead consensus earnings
estimates compiled by Thomson Financial First Call.—and the 10-year Treasury bond
yield (TBY). The average spread between the forward earnings yield and the Treasury
yield (i.e., FEY-TBY) is 29 basis points since 1979. This near-zero average implies that
the market is fairly valued when the two are identical:
1)
FEY = TBY
Of course, in the investment community, we tend to follow the price-to-earnings ratio more
than the earnings yield. The ratio of the S&P 500 price index to expected earnings (P/E) is
highly correlated with the reciprocal of the 10-year bond yield, and on average the two
have been nearly identical. In other words, the “fair value” price for the S&P 500 (FVP) is
equal to expected earnings divided by the bond yield in the Fed’s valuation model:
1
http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm
“We have not been able, as yet, to provide a satisfying answer to this question, but there are reasons in the
current environment to keep this question on the table.”
http://www.federalreserve.gov/boarddocs/hh/1997/february/testimony.htm
3
http://www.federalreserve.gov/boarddocs/hh/1997/july/ReportSection2.htm
2
Page 2 / August 13, 2001 / Deutsche Banc Alex. Brown US Stock Valuation & Allocation Models
2)
FVP = E/TBY
Excerpt from Fed’s July 1997 Monetary Policy Report:
The run-up in stock prices in the spring was bolstered by unexpectedly strong
corporate profits for the first quarter. Still, the ratio of prices in the S&P 500 to
consensus estimates of earnings over the coming twelve months has risen further from
levels that were already unusually high. Changes in this ratio have often been inversely
related to changes in long-term Treasury yields, but this year’s stock price gains were
not matched by a significant net decline in interest rates. As a result, the yield on tenyear Treasury notes now exceeds the ratio of twelve-month-ahead earnings to prices
by the largest amount since 1991, when earnings were depressed by the economic
slowdown. One important factor behind the increase in stock prices this year appears
to be a further rise in analysts’ reported expectations of earnings growth over the next
three to five years. The average of these expectations has risen fairly steadily since
early 1995 and currently stands at a level not seen since the steep recession of the
early 1980s, when earnings were expected to bounce back from levels that were quite
low.
The ratio of the actual S&P 500 price index to the fair value price shows the degree of
overvaluation or undervaluation. History shows that markets can stay overvalued and
become even more overvalued for a while. But eventually, overvaluation is corrected in
three ways: 1) falling interest rates, 2) higher earnings expectations, and of course, 3)
falling stock prices—the old fashioned way to decrease values. Undervaluation can be
corrected by rising yields, lower earnings expectations, or higher stock prices.
The Fed’s Stock Valuation Model worked quite well in the past. It identified when stock
prices were excessively overvalued or undervalued, and likely to fall or rise:
1) The market was extremely undervalued from 1979 through 1982, setting the stage for a
powerful rally that lasted through the summer of 1987.
2) Stock prices crashed after the market rose to a record 34% overvaluation peak during
September 1987.
3) Then the market was undervalued in the late 1980s, and stock prices rose.
4) In the early 1990s, it was moderately overvalued and stock values advanced at a
lackluster pace.
5) Stock prices were mostly undervalued during the mid-1990s, and a great bull market
started in late 1994.
6) Ironically, the market was actually fairly valued during December 1996 when the Fed
Chairman worried out loud about irrational exuberance.
Deutsche Banc Alex. Brown US Stock Valuation & Allocation Models / August 13, 2001 / Page 3
7) During both the summers of 1997 and 1998, overvaluation conditions were corrected
by a sharp drop in prices.
8) Then a two-month undervaluation condition during September and October 1998 was
quickly reversed as stock prices soared to a remarkable record 70% overvaluation
reading during January 2000. This bubble was led by the Nasdaq and technology
stocks, which crashed over the rest of the year, bringing the market closer to fair value.
II. New Improved Model
The FSVM is missing a variable reflecting that the forward earnings yield is riskier than
the government bond yield. How should we measure risk in the model? An obvious choice
is to use the spread between corporate bond yields and Treasury bond yields. This spread
measures the market’s assessment of the risk that some corporations might be forced to
default on their bonds. Of course, such events are very unusual, especially for companies
included in the S&P 500. However, the spread is only likely to widen during periods of
economic distress, when bond investors tend to worry that profits won’t be sufficient to
meet the debt-servicing obligations of some companies. Most companies won’t have this
problem, but their earnings would most likely be depressed during such periods. The
FSVM is also missing a variable for long-term earnings growth. My New Improved Model
includes these variables as follows:
3)
FEY = CBY – b • LTEG
where CBY is Moody’s A-rated corporate bond yield. LTEG is long-term expected
earnings growth, which is measured using consensus five-year earnings growth
projections. I/B/E/S International compiles these monthly. The “b” coefficient is the
weight that the market gives to long-term earnings projections. It can be derived as -[FEYCBY]/LTEG. Since the start of the data in 1985, this “earnings growth coefficient”
averaged 0.1.
Equation 3 can be rearranged to produce the following:
4)
FVP = E ÷ [CBY – b • LTEG]
FVP is the fair value price of the S&P 500 index. Exhibit 10 shows three fair value price
series using the actual data for E, CBY, and LTEG with b = 0.1, b = 0.2, and b = 0.25. The
market was fairly valued during 1999 and the first half of 2000 based on the consensus
forecast that earnings could grow more than 16% per year over the next five years and that
this variable should be weighted by 0.25, or two and a half times more than the average
historical weight.
III. Back To Basics
With the benefit of hindsight, it seems that these assumptions were too optimistic. But, this
is exactly the added value of the New Improved FSVM. It can be used to make explicit the
Page 4 / August 13, 2001 / Deutsche Banc Alex. Brown US Stock Valuation & Allocation Models
implicit assumptions in the stock market about the weight given to long-term earnings
growth. The simple version has worked so well historically because the long-term growth
component has been offset on average by the risk variable in the corporate bond market.
IV. Stocks Versus Bonds
The FSVM is a very simple stock valuation model. It should be used along with other
stock valuation tools, including the New Improved version of the model. Of course, there
are numerous other more sophisticated and complex models. The Fed model is not a
market-timing tool. As noted above, an overvalued (undervalued) market can become even
more overvalued (undervalued). However, the Fed model does have a good track record of
showing whether stocks are cheap or expensive. Investors are likely to earn below (above)
average returns over the next 12-24 months when the market is overvalued (undervalued).
The next logical step is to convert the FSVM into a simple asset allocation model (Exhibit 1
on front cover). I’ve done so by subjectively associating the “right” stock/bond asset mixes
with the degree of over/under valuation as shown in the table below. For example, whenever
stocks are 10% to 20% overvalued, I would recommend that a large institutional equity
portfolio should have a mix with 70% in stocks and 30% in bonds.
Stocks/Bonds Asset Allocation Model
More than 20% overvalued
60% stocks, 40% bonds
10% to 20% overvalued
70% stocks, 30% bonds
Less than 10% overvalued or undervalued
80% stocks, 20% bonds
10% to 20% undervalued
85% stocks, 15% bonds
More than 20% undervalued
90% stocks, 10% bonds
Deutsche Banc Alex. Brown US Stock Valuation & Allocation Models / August 13, 2001 / Page 5
#1
ED YARDENI’S ASSET ALLOCATION MODEL: STOCKS/BONDS
(for large equity funds)
Stocks overvalued when greater than zero
Stocks undervalued when less than zero
60/40
70/30
8/10
80/20
80/20
85/15
90/10
yardeni.com
79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
* Ratio of S&P 500 index to it’s fair value (12-month forward consensus expected operating
earnings per share divided by the 10-year US Treasury bond yield) minus 100. Monthly
through March 1994, weekly after.
Source: Thomson Financial
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
-5
-10
-15
-20
-25
-30
-35
-40
- Asset Allocation -
Page 6 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
-5
-10
-15
-20
-25
-30
-35
-40
- Valuation Model #2
1725
1575
1425
1275
1125
975
FED’S STOCK VALUATION MODEL
(ratio scale)
8/10
1725
1575
1425
1275
1125
975
825
S&P 500 Price Index
825
675
Fair-Value Price*
675
525
525
375
375
225
225
yardeni.com
75
75
79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
* 12-month forward consensus expected S&P 500 operating earnings per share divided by
10-year US Treasury bond yield. Monthly through March 1994, weekly after.
Source: Thomson Financial
#3
70
60
70
FED’S STOCK VALUATION MODEL*
(percent)
60
50
50
40
40
30
30
20
20
Overvalued
10
8/10
0
-10
Undervalued
-20
-30
-40
10
0
-10
-20
According to the
Fed model, when
stock prices are
overpriced, returns
from stocks are
likely to be subpar
over the next 12-24
months.
Better-than-average
returns tend to
come from
underpriced
markets.
-30
yardeni.com
-40
79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
* Ratio of S&P 500 Index to its Fair-Value (52-week forward consensus expected operating
earnings per share divided by the 10-year US Treasury bond yield) minus 100. Monthly
through March 1994, weekly after.
Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 7
- Valuation Model #4
18
This chart appeared
in the Fed’s July
1997 Monetary
Policy Report to the
Congress. It shows
a very close
correlation between
the earnings yield of
the stock market
and the bond yield.
Another, more
familiar way to look
at it follows.
18
S&P 500 EARNINGS YIELD & BOND YIELD
17
17
16
16
15
15
Forward Earnings Yield*
14
14
10-Year US Treasury
Bond Yield
13
13
12
12
11
11
10
10
9
9
8
8
7
7
6
6
5
8/10
4
5
4
3
3
yardeni.com
2
2
79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
* 12-month forward consensus expected S&P 500 operating earnings per share divided by
S&P 500 Index. Monthly through March 1994, weekly after.
Source: Thomson Financial
#5
The S&P 500 P/E
(using expected
earnings) is highly
correlated with
reciprocal of the
bond yield.
26
25
24
23
22
21
20
19
18
17
16
15
14
13
12
11
10
9
8
7
6
5
P/E & BOND YIELD
Ratio of S&P 500 Price to Expected Earnings*
8/10
Fair-Value P/E=Reciprocal of
10-Year US Treasury Bond Yield
Jun
Jul
Jul
Jul
Jul
Aug
Aug
29
6
13
20
27
3
10
Actual
21.7
21.8
21.4
21.7
21.5
21.9
21.5
Fair
18.9
18.5
18.8
19.4
19.4
19.5
19.7
yardeni.com
26
25
24
23
22
21
20
19
18
17
16
15
14
13
12
11
10
9
8
7
6
5
79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
* 12-month forward consensus expected S&P 500 operating earnings per share. Monthly through March
1994, weekly after.
Source: Thomson Financial
Page 8 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
- Earnings #6
75
70
75
S&P 500 EARNINGS PER SHARE
(analysts’ average forecasts)
Consensus Forecast
for 2001
70
Consensus Forecast
for 2002
65
65
Forward Earnings*
60
60
8/10
Consensus Forecast
for 2000
55
50
45
Expected forward
earnings is a
time-weighted
average of current
and the coming
years’ consensus
forecasts.
55
50
yardeni.com
I
45
II
2000
III
IV
I
II
2001
III
* 52-week forward consensus expected S&P 500 operating earnings per share.
Source: Thomson Financial
#7
65
65
S&P 500 EARNINGS PER SHARE: ACTUAL & EXPECTED
60
60
S&P 500 Earnings Per Share
________________________
55
50
45
Forward Earnings*
(pushed 52-weeks ahead)
Q1
8/9
55
50
Operating Earnings
(4-quarter sum)
45
40
40
35
35
30
30
25
25
20
20
15
15
10
yardeni.com
Bottom-up 52-week
forward expected
earnings tends to be
a good predicator of
actual earnings, with
a few significant
misses.
10
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
* 52-week forward consensus expected S&P 500 operating earnings per share. Monthly through
March 1994, weekly after.
Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 9
- Earnings #8
75
70
75
S&P 500 CONSENSUS OPERATING EARNINGS PER SHARE
(analysts’ bottom-up forecasts)
Consensus Forecasts
__________________
65
70
02
01
65
12-month forward
Annual estimates
60
00
99
60
Actual 4Q sum
55
50
55
50
97
96
45
40
35
Jul
98
45
40
95
91
94
93
92
35
30
30
25
25
yardeni.com
20
1990
Analysts always
start out too
optimistic about the
prospects for
earnings.
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
20
2002
Source: yardeni.com. Do not reprint without permission.
#9
35
35
S&P 500 CONSENSUS OPERATING EARNINGS PER SHARE
(analysts’ bottom-up forecasts, ratio scale)
30
30
Consenus Forecasts
_________________
89
12-month forward
88
Annual estimates
25
Actual 4Q sum
82
90
85
86
25
87
83
84
20
20
81
80
15
15
10
1978
yardeni.com
1979
1980
1981
1982
1983
1984
1985
1986
1987
Source: yardeni.com. Do not reprint without permission.
Page 10 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
1988
1989
1990
1991
10
- Earnings #10
25
25
S&P 500 EARNINGS PER SHARE
8/10
20
15
20
15
Consensus Growth
Forecasts*
_______________
10
10
2001/2000
2002/2001
5
5
0
0
-5
-5
8/10
-10
yardeni.com
-15
I
II
2000
III
IV
I
II
2001
The data on
consensus expected
earnings can be
used to derive
consensus earnings
growth forecasts.
-10
-15
III
* Based on consensus expected S&P 500 operating earnings for years shown.
Source: Thomson Financial
#11
35
30
35
S&P 500 OPERATING EARNINGS PER SHARE*
(yearly percent change)
30
Actual
25
25
Consensus Forecast (Proforma)*
20
20
15
15
10
10
5
5
0
Q4
0
-5
-5
-10
-10
-15
-15
yardeni.com
-20
1994
1995
1996
1997
1998
1999
2000
2001
Earnings growth is
highly cyclical.
-20
2002
* S&P 500 composition is constantly changing. Actual data are not adjusted for these changes.
Proforma forecasts are same-company comparisions. Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 11
- New Improved Model #12
2000
2000
NEW IMPROVED STOCK VALUATION MODEL
1800
1800
This New Improved 1600
Model builds on the
1400
simple one by
adding variables for
1200
long-term expected
earnings growth and 1000
risk.
1600
.25
S&P 500 Index
Fair Value*
5-year earnings
growth
weight
_____________
.25
1200
1000
.10
.20
800
Jul
.20
1400
800
.10
600
600
400
400
200
200
yardeni.com
0
0
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
* Fair Value is 12-month forward consensus expected S&P 500 operating earnings per share
divided by difference between Moody’s A-rated corporate bond yield less fraction (as shown
above) of 5-year consensus expected earnings growth.
Source: Thomson Financial
#13
30
Long-term earnings
growth expectations
rose sharply during
1990s. Now they
are coming back
down to the Planet
Earth.
30
LONG-TERM CONSENSUS EARNINGS GROWTH*
(annual rate, percent)
S&P 500
25
25
S&P 500
Technology
Ex Technology
20
20
Jul
15
yardeni.com
10
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
* 5-year forward consensus expected S&P 500 earnings growth.
Source: Thomson Financial
Page 12 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
15
10
- New Improved Model #14
40
MARKET’S WEIGHT FOR 5-YEAR CONSENSUS EXPECTED EARNINGS GROWTH*
(percent)
35
40
35
Weight market gives to long-term earnings growth
________________________________________
30
30
value > 13% = more than average weight
value < 13% = less than average weight
25
25
20
Jul
15
20
15
Average = 13%
10
10
5
5
0
0
yardeni.com
-5
Investors have on
average over time
subtracted 13% of
their long-term
earnings growth
expectations from
the corporate bond
yield to determine
earnings yield.
-5
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
* Moody’s A-rated corporate bond yield less earnings yield divided by 5-year consensus
expected earnings growth.
#15
1.6
1.6
S&P 500 PEG RATIO
1.5
1.4
1.5
P/E ratio for S&P 500
divided by 5-year consensus
expected earnings growth*
Jul
1.3
1.2
1.4
1.3
Average = 1.2
1.2
1.1
1.1
1.0
1.0
.9
.9
.8
yardeni.com
Historically, S&P
500 sold at P/E of
1.2 times long-term
expected earnings
growth, on average,
with quite a bit of
volatility.
.8
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
* P/E using 12-month forward consensus S&P 500 expected earnings and prices at mid-month.
Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 13
- New Improved Model #16
12
12
CORPORATE BOND YIELD
(percent)
11
11
10
10
A-Rated
9
9
8
8
8/10
7
Corporate bond
yield variable in
New Improved
Model captures risk
that earnings will be
weaker than
expected.
7
yardeni.com
6
6
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
* Source: Moody’s Investors Service
#17
300
250
300
CORPORATE SPREAD
(basis points)
Moody’s A-Rated corporate bond yield minus
10-Year US Treasury bond yield
8/10
200
250
200
Average = 156
150
150
100
100
yardeni.com
50
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Source: Moody’s Investor Service
Page 14 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
50
- Global: Stock Valuation #18
80
60
80
UNITED STATES
60
Overvalued
40
40
20
Jul
0
0
-20
-20
Undervalued
-40
-40
1995
30
1996
1997
1998
1999
2000
2001
30
UNITED KINGDOM
Overvalued
20
20
10
10
0
0
Undervalued
-10
Jul
-20
150
-10
-20
1995
200
20
1996
1997
1998
1999
2000
2001
200
JAPAN
150
100
100
Overvalued
50
50
0
0
-50
Undervalued
Jul
-100
-100
1995
80
60
1996
1997
1998
1999
2000
2001
80
GERMANY
60
Overvalued
40
40
20
20
0
Jul
-20
-40
1995
1996
1997
1998
1999
2000
2001
60
FRANCE
40
40
Overvalued
20
20
Jul
0
Undervalued
-20
0
-20
-40
-40
1995
50
0
-20
Undervalued
-40
60
-50
1996
1997
1998
1999
2000
2001
50
CANADA
Overvalued
30
30
10
10
Jul
-10
-10
Undervalued
yardeni.com
-30
1995
1996
1997
1998
1999
2000
-30
2001
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 15
- Global: Expected Earnings* -
#19
65
UNITED STATES (S&P 500)
325
GERMANY (DAX)
300
60
Jul
275
Jul
55
250
50
45
225
Expected EPS*
(dollars)
Expected EPS
(euros)
200
175
40
150
35
125
30
100
25
550
525
75
89 90 91 92 93 94 95 96 97 98 99 00 01 02
89 90 91 92 93 94 95 96 97 98 99 00 01 02
CANADA (TSE 300)
FRANCE (CAC 40)
280
260
500
Jul
240
475
Jul
450
425
Expected EPS
(euros)
Expected EPS
(Canadian dollars)
220
400
200
375
180
350
160
325
300
140
275
120
250
225
360
100
89 90 91 92 93 94 95 96 97 98 99 00 01 02
89 90 91 92 93 94 95 96 97 98 99 00 01 02
UNITED KINGDOM (FT 100)
JAPAN (TOPIX)
70
340
60
320
300
Jul
Expected EPS
(pounds)
Expected EPS
(yen)
Jul
280
50
260
40
240
220
30
200
yardeni.com
180
89 90 91 92 93 94 95 96 97 98 99 00 01 02
89 90 91 92 93 94 95 96 97 98 99 00 01 02
* 12-month forward consensus expected operating earnings per share. Source: Thomson Financial
Page 16 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
20
- Global: United States (S&P 500) -
#20
160
70
STOCK VALUATION MODEL
150
60
140
Jul
130
50
Industrial Production
(1987=100)
120
40
110
100
30
90
Expected Earnings Per Share*
For S&P 500 (dollars)
80
20
70
10
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
30
30
25
25
Fair-Value P/E
20
20
Jul
Forward P/E
15
15
10
10
5
5
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
1825
1475
1825
1475
Jul
1125
775
Stock Price Index (S&P 500)
(ratio scale)
425
Fair-Value Price
(ratio scale)
1125
775
425
75
75
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
70
70
60
60
50
50
40
40
30
30
Overvalued
20
20
Jul
10
10
0
0
-10
-10
Undervalued
-20
-20
-30
-30
yardeni.com
-40
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
-40
02
* Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 17
- Global: United Kingdom (FT 100) -
#21
110
350
STOCK VALUATION MODEL
Jul
105
300
100
Industrial Production
(1995=100)
250
95
200
Expected Earnings Per Share
for FT 100 (pounds)
90
85
150
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
25
25
23
23
21
21
Fair-Value P/E
Jul
19
19
Forward P/E
17
17
15
15
13
13
11
11
9
9
7
7
1988
1989
1990
1991
7900
7100
6300
5500
1992
1993
1994
1995
1996
1997
1998
1999
2000
Stock Price Index (FT 100)
(ratio scale)
4700
2001
2002
7900
7100
6300
5500
Jul
4700
Fair-Value
(ratio scale)
3900
3900
3100
3100
2300
2300
1500
1500
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
40
40
30
30
20
20
Overvalued
10
10
0
0
-10
Jul
Undervalued
-10
yardeni.com
-20
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
* Source: Thomson Financial
Page 18 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
2000
2001
2002
-20
- Global: Japan (TOPIX) -
#22
115
60
STOCK VALUATION MODEL
Expected Earnings Per Share
for TOPIX (yen)
110
50
Jul
105
Industrial Production
(1995=100)
40
100
30
95
90
20
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
150
150
Fair-Value P/E
100
100
Forward P/E
Jul
50
50
0
0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
4500
4500
4000
4000
3500
3500
3000
3000
Stock Price Index (TOPIX)
2500
2500
Fair-Value
2000
2000
1500
1500
Jul
1000
1000
500
500
0
0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
300
300
Overvalued
200
200
100
100
0
-100
0
Undervalued
Jul
yardeni.com
1991
-100
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
* Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 19
- Global: Germany (DAX) -
#23
120
325
STOCK VALUATION MODEL
300
Jul
110
275
250
Industrial Production
(1995=100)
225
200
175
100
150
Expected Earnings Per Share
for DAX (Euros)
125
100
90
75
1991
1992
1993
1994
1995
34
32
30
28
26
24
22
20
18
16
14
12
10
8
1996
1997
1998
1999
2000
2001
2002
34
32
30
28
26
24
22
20
18
16
14
12
10
8
Fair-Value P/E
Forward P/E
Jul
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
11000
11000
9000
9000
7000
7000
5000
Stock Price Index (DAX)
(ratio scale)
3000
Fair-Value
(ratio scale)
Jul
5000
3000
1000
1000
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
70
70
60
60
50
50
40
40
Overvalued
30
30
20
20
10
10
0
0
Jul
-10
-10
Undervalued
-20
-20
-30
yardeni.com
-40
1991
1992
1993
1994
1995
1996
1997
1998
1999
* Source: Thomson Financial
Page 20 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
2000
2001
2002
-30
-40
- Global: France (CAC 40) -
#24
120
118
275
STOCK VALUATION MODEL
Jul
116
114
250
225
112
200
110
Industrial Production
(1995=100)
108
175
106
150
104
Expected Earnings Per Share
for CAC 40 (Euros)
102
100
125
98
100
1995
1996
1997
1998
1999
2000
2001
29
29
27
27
25
Fair-Value P/E
25
23
Forward P/E
23
21
21
Jul
19
19
17
17
15
15
13
13
11
11
1995
1996
1997
1998
1999
2000
2001
7900
7100
6300
5500
7900
7100
6300
5500
Jul
Stock Price Index (CAC 40)
(ratio scale)
4700
3900
4700
3900
Fair-Value
(ratio scale)
3100
3100
2300
2300
1500
1500
1995
1996
1997
1998
1999
2000
2001
60
60
40
40
Overvalued
20
20
Jul
0
Undervalued
-20
-20
yardeni.com
-40
1995
1996
1997
0
1998
1999
2000
-40
2001
* Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 21
- Earnings & Output: G6 #25
200
200
GLOBAL G6 EARNINGS INDEX*
(Jan 1989=100)
180
180
Jul
The yearly percent
change in our Index
of Global G6
Earnings is highly
correlated with the
growth of G7
industrial
production.
160
160
140
140
120
120
100
100
yardeni.com
80
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
80
2002
* Half US and half G5 (Canada, France, Germany, Japan and United Kingdom) 12-month
forward consensus expected operating earnings.
#26
30
8
GLOBAL G6 EARNINGS & PRODUCTION
(yearly percent change)
25
6
20
15
4
10
2
5
0
0
G6 Earnings Index*
-5
Jul
-2
G7: Industrial Production
-10
yardeni.com
-15
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
* Half US and half G5 (Canada, France, Germany, Japan and United Kingdom) 12-month
forward consensus expected operating earnings.
Page 22 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
-4
- Earnings & Output: US #27
160
65
S&P 500 EARNINGS & INDUSTRIAL PRODUCTION
60
150
8/10
55
140
130
S&P 500 Forward Earnings*
50
Industrial Production
(1992=100)
45
120
40
110
35
30
100
25
90
20
80
15
70
10
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
Strong correlation
between US
industrial production
and S&P 500
forward earnings.
* 52-week forward consensus expected operating earnings per share. Monthly through
March 1994, weekly after.
Source: Thomson Financial
#28
30
30
S&P 500 EARNINGS & PRODUCTION
(yearly percent change)
25
25
20
20
15
15
10
10
5
5
0
0
Jun
-5
-10
S&P 500 Forward Consensus Earnings*
-15
Industrial Production
-20
8/10
-5
-10
-15
yardeni.com
-20
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
* 52-week forward consensus expected earnings. Monthly through March 1994, weekly after.
Source: Thomson Financial First Call
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 23
- Earnings & Output: US #29
86
25
S&P 500 EARNINGS & CAPACITY UTILIZATION
85
Total Capacity Utililzation
(percent)
20
84
Growth in S&P 500
forward earnings
highly correlated
with US capacity
utilization rate.
Profits tend to
increase (decrease)
whenever utilization
rate is above
(below) 79%.
83
15
82
10
81
80
5
79
0
78
77
Jun
-5
S&P 500 Forward Earnings*
(yearly percent change)
76
-10
8/10
75
74
-15
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
* 12-month forward consensus expected operating earnings per share. Monthly through
March 1994, weekly after.
Source: Thomson Financial.
#30
16
14
2-to-1 is the unusual
ratio between
growth in S&P 500
forward earnings
and growth in G7
production.
32
S&P 500 EARNINGS & G7 INDUSTRIAL PRODUCTION
(yearly percent change)
28
12
24
10
20
8
16
6
12
4
8
2
4
0
0
Apr
-2
-4
-4
-8
S&P 500 Forward Earnings*
8/10
-6
-12
G7 Industrial Production
-8
-16
yardeni.com
-10
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
* 12-month forward consensus expected operating earnings per share. Monthly through
March 1994, weekly after. Source: Thomson Financial
Page 24 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
-20
- Earnings & Output: Europe #31
50
50
GERMANY: EARNINGS & ORDERS
(yearly percent change)
40
40
30
30
20
20
10
10
0
0
Jun
Jul
-10
-10
-20
-20
Forward Earnings*
Total Manufacturing Orders
-30
-30
yardeni.com
-40
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
-40
2002
* 12-month forward consensus expected operating earnings per share for DAX.
Source: Thomson Financial
#32
50
50
GERMANY: EARNINGS & IFO INDEX
(yearly percent change)
40
40
30
30
20
20
10
10
0
0
German corporate
profits highly
correlated with
factory orders and
business
confidence.
Jul
-10
-10
Jun
-20
-20
Forward Earnings*
IFO Business Climate Index
-30
-30
yardeni.com
-40
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
-40
2002
* 12-month forward consensus expected earnings per share for DAX.
Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 25
- Earnings & Output: Europe #33
120
275
FRANCE: EARNINGS & PRODUCTION
118
116
250
Jul
114
Forward Earnings*
112
225
Industrial Production
(1995=100)
110
108
200
106
104
175
102
100
150
98
96
125
94
yardeni.com
92
1991
Industrial production
is key variable
driving profits in
France and UK.
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
100
2002
* 12-month forward consensus expected earnings per share for CAC 40.
Source: Thomson Financial
#34
110
340
UNITED KINGDOM: EARNINGS & PRODUCTION
108
320
Jul
106
300
104
102
280
100
260
98
Forward Earnings*
240
96
Industrial Production
(1995=100)
94
220
92
200
90
yardeni.com
88
1991
1992
1993
1994
1995
1996
1997
1998
1999
* 12-month forward consensus expected earnings per share for FT 100.
Source: Thomson Financial
Page 26 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
2000
2001
2002
180
- Earnings & Output: Japan #35
115
60
JAPAN: EARNINGS & PRODUCTION
Forward Earnings*
110
Industrial Production
(1995=100)
50
Jul
105
40
100
30
95
yardeni.com
90
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
20
2002
* 12-month forward consensus expected operating earnings per share for TOPIX.
Source: Thomson Financial
#36
100
60
JAPAN: EARNINGS & TANKAN BUSINESS CONDITIONS
Japan is falling into
recession again.
Weak yen boosts
exporters’ earnings.
But profits are likely
to weaken along
with economy.
Forward Earnings*
75
Tankan Business Conditions:
Major Manufacturers
(diffusion index)
50
50
Jul
25
40
0
30
Q2
-25
yardeni.com
-50
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
20
2002
* 12-month forward consensus expected earnings per share for TOPIX.
Source: Thomson Financial
Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 27
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