Posted on December 20th, 2012 No comments
Posted on June 6th, 2012 No comments
After trading up in a risk-approving enviornment for almost three months, stock markets in the US and Europe started to reverse in March and accelerated the fall through April and May. All major European stock indicies as well as e.g. the DJIA is now in red for the year. Yesterday the ECB published data showing that, for the twelfth consecutive week, its purchase volumes of eurozone nation’s bonds were zero. In the last six months, there has been a strong correlation between central bank interventions, lower yields on troubled eurozone nation’s bonds and rising stock markets. The ECB jumped in to rescue Italy in December 2011 and at the same time it launched LTRO (effectively risk-free money for Europe’s banks), which triggered the bull market that later peaked in March this year. If there ever was any doubt that ECB’s Securities Market Programme (SMP) was effective, the graph below (click to enlarge) will remove all doubt. It speaks for itself: Spain can no longer finance its debt through the regular bond market. The ECB will have to resume purchase of Spaniard bonds on the secondary market – or launch a broader measure like LTRO3.
Posted on November 10th, 2011 No comments
As Italian 10-year bond yields were edging over 7%, stock markets around Europe and in the US were gradually falling. At the same time Italy’s head of state, Giorgio Napolitano, felt compelled to assure the markets that there were no doubts that Silvio Berlusconi would resign and that the Italian parliament would soon (“in the space of a few days”) pass austerity plans.
Economists around the world are now quite unified in their judgement, namely that the only possible solution to this immediate crisis is for the ECB to bring out the big guns and intervene massively in the bond market.
In difficult situations like these, one shall always bear in mind that the best investments are made when everyone is pessimistic about the future and running away from the stock market. So is this a good time to buy shares? No. We are not there yet. The two most fundamental reasons why:
1) Stock markets are up since the beginning of October. Markets have edged on good performing quarterly reports and hopes for a Greek solution. And even if some stocks seem like good buys in the long run, it’s always better to buy even cheaper. Things will quite certainly get worse before they get better.
2) The ECB and European leaders can not keep up with the pace of global markets. And if the ECB won’t save Italy, no-one will. In this way Italy will default simply because it will be cut off from the credit markets. If Italy defaults – the end of the Euro zone?
You can expect a lot of market turmoil in the next few weeks, so instead of waiting for those big guns to come out – drop your shares and stay back for a while.
Posted on August 22nd, 2011 No comments
You know the story: Stock markets are falling sharply as big international investors are getting out of their way to avoid risk. In times of huge uncertainty it’s often more useful to figure out what kind of scenarios the current market prices reflect rather than following standard process and trying to produce earning estimates as such have proven notoriously unreliable in rapidly changing markets. One of the companies we follow and analyze very closely at Stretch Target is Scania AB, which is our target also for this analysis.
We start our analysis by looking back at Scania’s performance in the midst of the 2008-2009 financial crisis which hit the automobile and truck industry extremely hard.
Looking at the quarterly reports, we note that Q3 2009 was worst in terms of Sales decline (-34% year-on-year) and Q2 was worst in terms of operating income (+/-0). The first half of 2009 displayed a record low operating margin of 1,7%. The company only reported negative EPS during one single quarter, the EPS plunge was as swift as the recovery (see picture 1 below).
Using this past data and the current share price for SCV B in our Stretch Target Regression Model (STRM), we can produce the future EPS and growth rates currently reflected in the share price.
- the 2009 EPS of 1,41 SEK is set as worst case in the next downturn
- the next EPS decline will start in Q3 2011 (now) and last longer than the previous one
- The risk-free interest rate is now as low as 2,2% for a 10 year Swedish government bond. However, this change is offset by the increase in market risk premium
- SCV B closed today at 100,00 SEK.
The result is quite astonishing. The EPS for 2011 is set as low as 9,57 (analyst estimates at Scania’s homepage is still as high as 12,68) which corresponds to Scania having a good Q3 in line with the previous quarters but that Q4 coming out at worst case lows. This will be followed by a worst case 2012, a recovery during 2013 and consolidation at 2011 level in 2014 (see picture 2 to the left). However a long term growth rate of 3% will mean that EPS will reach 2010 levels in 2022!
It’s up to the reader to decide if such scenario is realistic or not. At Stretch Target we deem this to be too pessimistic. Looking at how well prepared Scania is for a coming downturn, we observe that the Equity/Assets ratio increased impressively from 20,9% after Q2 2008 to 30,3% after Q2 2011. We conclude the analysis by noting that
i) Scania is at present even better prepared for an economic downturn than in 2008
ii) Even if we accept the fairly pessimistic scenario above, a long term growth rate of 3% is too pessimistic. Increasing that to 4% yields a 10% upside on the share price.
Posted on October 29th, 2010 No comments
In a previous article I argued that the Fed, due to the high stakes involved, would act very carefully when withdrawing from the unconventional monetary policy of near-zero interest rates and massive Quantitative Easing (QE). I took this as a reason to stay in the stock market despite the obvious risk that this type of policy can create asset bubbles. Nine months later the amount of securities held by the Fed is still around $2 trilion and there’s no sign of interest rate increases. Au contraire the minutes from the Fed’s meeting held on September 21st have given rise to speculations about the emergence of a second stimulus package commonly dubbed QE2.
So what’s happened on the stock market during these nine months? The S&P500 is up 8% from 1097 to 1184 overcoming a 15% slump as the European sovereign debt crisis unveiled in April-May. The USD is at 0,72 EUR, which is roughly unchanged compared with nine months ago. Meanwhile, the broad index on our home market, the OMX_Stockholm_PI, is up by 14%. During this time the Swedish Riksbank has increased its interest rate in three steps from 0,25% to 1,00%. Many large companies, both US and Swedish ones, are publishing record profits and accumulating cash. I general, demand and sales have some way to go before reaching the top levels of spring 2008, but profit margins are very high due to massive and swift cost cutting during 2009.
So it seems like staying on the stock market for the discussed period was a good choice, but what about the nine months to come? The Fed’s policy isn’t the only input to that analysis of course but the U.S. still play a major role in the global economy and companies everywhere are either directly or indirectly dependent on the U.S. and the value of the USD.
My reasoning goes like this: Profit margins can’t get much higher, if share prices are to rise it needs to be through expected sales growth. In the U.S. this cannot, as in previous upturns, depend on domestic private consumption. The U.S. households simply have to pay back debt, and so does the government. Domestic demand is sluggish, the current GDP growth rate is 2%; way lower that during previous recession recoveries. I doubt that the intention with QE2 would be to lower interest rates further in order to stimulate domestic investment and spending. The main intention would be to increase inflation and thereby (lowering real interest rates and) depreciating the USD. A cheaper USD would stimulate U.S. exports, improve the current account balance and create growth for U.S.-based global companies. Increased inflation will also ease the burden for heavily indebted households.
This strategy may or may not work. But if it is executed and fails to spur growth, the Fed may be stuck in a liquidity trap from which it can’t get out without severely hurting demand. Hence, QE2 will be a very dangerous route to take. As an investor outside the U.S., I will stay away from the U.S. stock market and from companies with high U.S. exposure, large sales or pricing in USD, until it has been proven that the U.S. economy can grow at an annual rate above 3%.