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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