Table Of Contents. Table Of Contents. Yardeni Research, Inc. S&P 500 Sectors Total Forward Earnings49

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1 Table Of Contents Table Of Contents Dr. Ed s Forecasts A: GDP Forecast Table 1 B: S&P Earnings Forecasts 2 C: S&P Industry Overweights 3 D: S&P Industry Underweights 4 E: S&P Industry Performance F: O-M-U Recommendations 6 Figures Debt Great Crashes 6 Liquidity 7 Interest Rate Spreads Stock Prices & Fundamentals 9 Fed s Balance Sheet 1 Treasuries & Agencies 11 S&P Market Bottoms US Stock Price Trends 13 World Stock Price Indexes 14 Global Stock Markets (ytd) Profits 16 Profits & Sales 17-1 Profit Margin 19 Cash Flow 2 S&P Write-Offs 21 S&P Dividends 22 S&P Dividend Yield 23 S&P /4/6 Quarterly Earnings 9 24 S&P Earnings Squiggles: Monthly 2 S&P /4/6 Squiggles: Weekly 26 S&P Forward Earnings 27 Forward Earnings & Sales 2 Forward Earnings & Orders 29 Forward Earnings: Industrial Shipments 3-31 Forward Earnings: IT & Semis 32 Forward Earnings: Semi Equipment 33 Forward Earnings: Materials & Energy 34 Forward Earnings: Energy 3 Forward Earnings: Diversified Banks 36 Valuation: P/E Ratios 37 Valuation: P/E & q 3 Valuation: SVM-1 39 Valuation: SVM-2 4 Valuation: Equity Risk Spread 41 Valuation: Rules of 2 42 Valuation: Bond Yield 43 Valuation: Market Cap 44 Market Cap 4 S&P Sector Shares S&P /4/6 YTD 4 S&P Sectors Total Forward Earnings49 tember 2, 9 / Strategist s Handbook

2 - A: GDP Forecast Table - Page 1 / tember 2, 9 / Strategist s Handbook

3 - B: S&P Earnings Forecasts - Page 2 / tember 2, 9 / Strategist s Handbook

4 - C: S&P Industry Overweights - Page 3 / tember 2, 9 / Strategist s Handbook

5 - D: S&P Industry Underweights - Page 4 / tember 2, 9 / Strategist s Handbook

6 - E: S&P Industry Performance - Page / tember 2, 9 / Strategist s Handbook

7 - F: O-M-U Recommendations - Page 6 / tember 2, 9 / Strategist s Handbook

8 - Debt - 4 Figure 1. DEBT (as a percent of nominal GDP) 4 Total debt excluding US Treasury debt probably peaked relative to GDP during -. 3 Total Debt Minus US Treasury Debt / GDP US Treasury Debt / GDP Source: Federal Reserve Board, Flow of Funds Accounts. 2 Figure 2. BORROWING BY NONFINANCIAL SECTORS (as a percent of nominal GDP) 2 Households Plus Business / GDP Over the past four quarters, pace of borrowing by households and business plunged, while US Treasury borrowing soared. 1 US Treasury / GDP Source: Federal Reserve Board, Flow of Funds Accounts. - Page / tember 2, 9 / Strategist s Handbook

9 - Great Crashes - 4 Figure 3. DOW JONES INDUSTRIALS AVERAGE 4 The Great Crash occurred after Congress enacted the Smoot-Hawley Tariff (SHT). DJIA fell 26.3% from tember 1929 peak through May 193. It then plunged 2.% through July Smoot-Hawley Tariff, June Source: Haver Analytics. 6 Figure 4. CRB INDUSTRIALS SPOT PRICE INDEX (1967=) AIG/Lehman Collapse, tember, 6 Commodity prices plunged after mid-tember, but have recovered smartly so far this year. 9/ Source: Commodity Research Bureau. Page 6 / tember 2, 9 / Strategist s Handbook

10 - Liquidity - Figure. MZM* & SMALL TIME DEPOSITS (trillion dollars, sa) 9/ MZM* + Small Time Deposits MZM* Savings Deposits 6 Small Time Deposits + Money Market Mutual Funds** Liquid assets at record high. * MZM equals M2 minus small-denomination time deposits plus institutional money market mutual funds. ** Held by individuals and institutions. Source: Board of Governors of the Federal Reserve System. 1 Figure 6. MZM* PLUS SMALL TIME DEPOSITS (as a percentage of Wilshire ) / * MZM equals M2 minus small-denomination time deposits plus institutional money market mutual funds. Source: Board of Governors of the Federal Reserve System and Wilshire Associates. Page 7 / tember 2, 9 / Strategist s Handbook

11 Figure 7. US TREASURY 2-YEAR NOTE & FED FUNDS RATES (percent) - Interest Rate Spreads - 2-Year Treasury Note Yield Federal Funds Rate Target TED SPREAD: UK LIBOR RATE LESS US TREASURY BILL RATE (basis points, using 3-month rates) 9/ BOND SPREADS OVER 1-YEAR TREASURY (basis points) Seasoned Baa-Rated Corporate Bond Yield Seasoned Aaa-Rated Corporate Bond Yield AAA Municipal 3-Year Bond Yield /2 9/ Page / tember 2, 9 / Strategist s Handbook

12 - Stock Prices & Fundamentals - 13 Figure. S&P INDEX vs. FUNDAMENTAL STOCK MARKET INDICATOR 16 Fundamental Stock Market Indicator is confirming S&P rally Average of Consumer Comfort Index and BBB* S&P Index / / * CRB raw industrials spot price index divided by initial unemployment claims, four-week moving average. Source: ABC News/Washington Post, Commodity Research Bureau, Department of Labor and Standard & Poor s Corporation. 3 Figure 9. S&P TRANSPORTATION INDEX vs. RAILCAR LOADINGS 6 Plunge in railcar loadings isn t confirming rally in Transports / Total Railcar Loadings (thousand units, 26-wa) 46 S&P Transportation Index 9/ Source: Atlantic Systems and Standard and Poor s. 42 Page 9 / tember 2, 9 / Strategist s Handbook

13 - Fed s Balance Sheet Figure 1. FED S ASSETS* (trillion dollars) US Treasuries + Agency Debt + MBS Liquidity Facilities 9/23 I II III IV I II III IV 9 FED S LIABILITIES* (trillion dollars) Total 9/23 I II III IV I II III IV US Treasury Securities Agency Debt + MBS 9/23 US Treasury Deposits at Fed (General & Supplementary) 9/ I II III IV I II III IV 9 I II III IV I II III IV Term Auction Credit Net Portfolio Holdings of Commercial Paper Funding Facility 9/23 Reserve Balances with Fed (Depository Institutions Deposits at Fed) 9/ I II III IV I II III IV 9 I II III IV I II III IV Central Bank Liquidity Swaps Federal Reserve Notes 9/ Other Loans /23 I II III IV I II III IV 9 *Average of daily figures for weeks ending Wednesdays. Source: Federal Reserve Board. I II III IV I II III IV Page 1 / tember 2, 9 / Strategist s Handbook

14 - Treasuries & Agencies - 3 Figure 11. US TREASURIES HELD BY ALL CENTRAL BANKS (billion dollars) Total US Treasuries Held By Central Banks Held By Foreign Central Banks Held By Fed 9/ US AGENCIES HELD BY ALL CENTRAL BANKS (billion dollars) 9/ Total Agencies Held by Central Banks Held By Foreign Central Banks Held By Fed US TREASURIES & AGENCIES HELD BY ALL CENTRAL BANKS (billion dollars) 9/ Total US Treasuries & Agencies Held by Central Banks Held By Foreign Central Banks Held By Fed *Average of week ending Wednesday. Source: Federal Reserve Board, Table H.4.1. Page 11 / tember 2, 9 / Strategist s Handbook

15 - S&P Market Bottoms - 16 Figure. P P T / P T I II III IV I II III I II III IV I II III T P T S&P INDEX (ratio scale) I II III IV I II III IV P/T = peaks and troughs of business cycle. Grey shaded areas are bear markets. Source: Standard & Poor s Corporation....-day moving avg Page / tember 2, 9 / Strategist s Handbook

16 The S&P has increased at a compounded rate of 6% per year on average since Figure US Stock Price Trends - S&P INDEX* (ratio scale) 7% Aug % * Growth paths are compounded monthly to yield % and 7% annually. Note: Shaded areas are recessions according to the National Bureau of Economic Research. Source: Standard & Poor s Corporation. DJIA trading below 1, again since October Figure 14. DOW JONES INDUSTRIALS (ratio scale) 1, Aug Note: Shaded areas are recessions according to the National Bureau of Economic Research. Source: Dow Jones Inc. Page 13 / tember 2, 9 / Strategist s Handbook

17 - World Stock Price Indexes Figure. SHARE PRICE INDEXES (ratio scale) World 9/ Europe 9/ EAFE* 9/ Emerging Markets 9/ Emerging Markets: Asia 9/ Emerging Markets: Latin America 9/ *Europe, Australia, and Far East. Source: Morgan Stanley Capital International. 6 Page 14 / tember 2, 9 / Strategist s Handbook

18 - Global Stock Markets (ytd) - Figure 16. ARGENTINA Merval AUSTRALIA All Ordinaries BRAZIL Bovespa CANADA Toronto CHILE IGPA General CHINA Dow Jones Shanghai Composite CZECH REPUBLIC PX EGYPT Cairo SE General FRANCE CAC GERMANY DAX HONG KONG Hang Seng HUNGARY BUX INDIA Bombay Sensex INDONESIA Jakarta ISRAEL Tel Aviv ITALY FTSE MIB MALAYSIA Kuala Lumpur MEXICO Bolsa NETHERLANDS Amsterdam PAKISTAN Karachi PERU Lima THE PHILIPPINES Manila RUSSIA RTS SINGAPORE Straits Times SOUTH KOREA Kospi SWEDEN AffarsvardnGen SWITZERLAND SMI TAIWAN TWSE THAILAND Bangkok TURKEY IMKB National UNITED KINGDOM FTSE 16.4 Jan Feb Mar Apr May Jun Jul Aug Oct Nov Dec 9 Source: Haver Analytics UNITED STATES S&P Index.6 Jan Feb Mar Apr May Jun Jul Aug Oct Nov Dec VENEZUELA IBC 47.2 Jan Feb Mar Apr May Jun Jul Aug Oct Nov Dec 9 Page / tember 2, 9 / Strategist s Handbook

19 NIPA after-tax profits based on tax returns increased for the second time in six quarters during. This measure of profits excludes write-offs, so it is similar to S&P operating net income rather than to S&P reported net income. Cash flow profits (from current production) also moving higher Figure 17. S&P & NIPA CORPORATE PROFITS* (billion dollars) NIPA After Tax Profits (saar) Based on Tax Returns* - Profits - From Current Production** S&P Net Income (4-quarter sum) Operating Reported Q * Excluding IVA & CCadj. ** Including IVA & CCadj. These two adjustments restate the historical cost basis used in profits tax accounting for inventory withdrawals and depreciation to the current cost measures used in GDP. Source: US Department of Commerce, Bureau of Economic Analysis, and Standard & Poor s Corporation Figure 1. S&P OPERATING NET INCOME (4-quarter sum) (as a ratio of NIPA after-tax corporate profits based on tax returns, 4-quarter sum)* When this ratio is above (below) average, S&P earnings may overstate (understate) actual profits Average = Q * Excluding IVA & CCadj. These two adjustments restate the historical cost basis used in profits tax accounting for inventory withdrawals and depreciation to the current cost measures used in GDP. Source: US Department of Commerce, Bureau of Economic Analysis, and Standard & Poor s Corporation. Page 16 / tember 2, 9 / Strategist s Handbook

20 In recent years, above-trend growth in profits was attributable to overseas profits and earnings of Financials. Both remain weak, though the latter turned up last quarter Figure Profits & Sales - NOMINAL GDP & AFTER-TAX CORPORATE PROFITS (196=, ratio scale) 7% Growth Path* Nominal GDP After-Tax Corporate Profits Reported to IRS From Current Production** * Compounded monthly to yield 7% annually. ** Includes IVA & CCAdj. These two adjustments restate the historical costs basis used in profits tax accounting for inventory withdrawals and depreciation to the current cost measures used in GDP. Source: US Department of Commerce, Bureau of Economic Analysis. These three alternative measures of earnings often tell three different stories. The market has tended to discount the most optimistic of the three, i.e., forward earnings Figure 2. S&P EARNINGS PER SHARE (ratio scale, dollars) S&P Earnings Per Share* Reported (4-quarter sum) Operating** (4-quarter sum) Forward*** 7% % * Growth paths are compounded monthly to yield % and 7% annually. ** Excludes write-offs. *** 2-week forward consensus expected S&P operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Monthly through April 1994; weekly thereafter. Source: Standard & Poor s Corporation and Thomson Financial. Page 17 / tember 2, 9 / Strategist s Handbook

21 Figure Profits & Sales - S&P OPERATING EARNINGS & BUSINESS SALES (yearly percent change) 4 Growth rates in S&P operating earnings and business sales are highly correlated Q1 S&P Operating Earnings Business Sales* * Manufacturing and trade sales. Source: Thomson Financial and US Department of Commerce, Bureau of the Census. 4 Figure 22. CORPORATE PROFITS FROM THE REST OF THE WORLD* (as a percent of corporate profits) 4 Profits from overseas share of total profits down from record high, but still above 3%. 4 3 Receipts Source: US Department of Commerce, Bureau of Economic Analysis. Page 1 / tember 2, 9 / Strategist s Handbook

22 Profit Margin - Figure 23. PRE-TAX CORPORATE PROFITS FROM CURRENT PRODUCTION* As a percent of National Income As a percent of Nominal GDP AFTER-TAX PROFIT MARGIN FROM CURRENT PRODUCTION* (percent) All Corporations Average = 1.4% AFTER-TAX PROFIT MARGIN & CAPACITY UTILIZATION After-Tax Nonfinancial Corporate Profit Margin* 9 Capacity Utilization: All Industries *Includes IVA & CCAdj. These two adjustments restate the historical-cost basis used in profits tax accounting for inventory withdrawals and depreciation to the current-cost measures used in GDP. Note: Shaded areas are recessions according to the National Bureau of Economic Research. Source: Federal Reserve Board and US Department of Commerce, Bureau of Economic Analysis. Page 19 / tember 2, 9 / Strategist s Handbook

23 Corporate cash flow stalled near recent record highs Figure 24. CORPORATE CASH FLOW (ratio scale, billion dollars, saar) - Cash Flow - Corporate Cash Flow* Economic Depreciation** Tax-Reported Depreciation*** * After-tax retained earnings plus tax-reported depreciation. ** Corporate capital consumption allowances. *** Corporate capital consumption allowances with capital consumption adjustment. Source: US Department of Commerce, Bureau of Economic Analysis. Inventory Valuation Adjustment volatile recently Figure 2. INVENTORY VALUATION ADJUSTMENT* (billion dollars, saar) CAPITAL CONSUMPTION ADJUSTMENT* (billion dollars, saar) Tax-Reported > Economic Depreciation Tax-Reported < Economic Depreciation * These two adjustments restate the historical cost basis used in profits tax accounting for inventory withdrawals and depreciation to the current cost measures used in GDP. Source: US Department of Commerce, Bureau of Economic Analysis. Page 2 / tember 2, 9 / Strategist s Handbook

24 2 2 Figure S&P Write-Offs - S&P OPERATING VS REPORTED EARNINGS PER SHARE (dollars) Operating Reported During H1-9, reported earnings rebounded as write-offs increased at a much slower pace than during Q4-. Operating earnings also recovered during H Source: Standard & Poor s Corporation. Figure 27. S&P WRITE-OFFS PER SHARE* (dollars) Quarter Sum Actual x * Operating less reported earnings per share. Source: Standard & Poor s Corporation. Page 21 / tember 2, 9 / Strategist s Handbook

25 Retained earnings remained in recession during Figure 2. - S&P Dividends - S&P DIVIDENDS & RETAINED EARNINGS PER SHARE (dollars, trailing 4-quarter sum, ratio scale) Dividends Retained Earnings* * Reported earnings minus dividends per share. Source: Standard & Poor s Corporation. The average dividend payout ratio (using reported earnings) dropped from % during the 19s and 196s to 44% during the 197s, 43% during the 19s, and 41% during the 199s. It soared at the end of last year. The percentage of S&P companies paying dividends increased from 7.2% in 2 to 77.% in 7 from 77.% in Figure 29. S&P DIVIDEND PAYOUT RATIOS* (percent) S&P S&P Industrials S&P COMPANIES PAYING A DIVIDEND (percent of total) * Four-quarter trailing dividends per share divided by four-quarter trailing reported earnings. Source: Standard & Poor s Corporation and FactSet. Page 22 / tember 2, 9 / Strategist s Handbook

26 - S&P Dividend Yield - 2 Figure 3. TREASURY BILL YIELD VS S&P DIVIDEND YIELD (percent) 2 The dividend yield exceeds the T-bill rate. Three-Month Treasury Bill Yield S&P Dividend Yield* 1 1 Q1 Aug * S&P four-quarter trailing dividends per share divided by quarterly closing S&P index. Source: Standard & Poor s Corporation and Board of Governors of the Federal Reserve System Figure 31. S&P DIVIDEND YIELD (trailing 4-quarter sum) Dividend yields tend to rise over time relative to the initial sum invested Invested in 197 Invested in 19 Invested in Source: Standard & Poor s Corporation. 4 2 Page 23 / tember 2, 9 / Strategist s Handbook

27 Figure 32. S&P EARNINGS PER SHARE: CONSENSUS QUARTERLY FORECASTS* (weekly, analysts average forecasts in dollars) 9 By Quarter (as of 9/2/9) 1 Q Q3 Q1 1 III IV I II III IV I S&P 4 MIDCAP EARNINGS PER SHARE: CONSENSUS QUARTERLY FORECASTS* 19 (weekly, analysts average forecasts in dollars) 17 - S&P /4/6 Quarterly Earnings By Quarter (as of 9/2/9) Q1 Q4 Q3 9 7 III IV I II III IV I S&P 6 SMALLCAP EARNINGS PER SHARE: CONSENSUS QUARTERLY FORECASTS*. (weekly, analysts average forecasts in dollars) By Quarter 6. (as of 9/2/9) Q4 3. Q Q III IV I II III IV I 9 21 * Consensus expected S&P 6 SmallCap operating earnings per share for each quarter shown. Source: Thomson Financial Page 24 / tember 2, 9 / Strategist s Handbook

28 - S&P Earnings Squiggles: Monthly - Figure 33. S&P OPERATING EARNINGS PER SHARE (analysts average forecasts, ratio scale) 7 9 In the past, Earnings Squiggles showed that analysts were usually overly optimistic about the earnings outlook. Consensus annual earnings forecasts rose in 4 (for the first time since 199) and also in and 6. They ve been falling since Q3-7. Earnings estimated to fall.7% in 9 and then rise 2.7% in Consensus Forecasts month forward* Annual estimates * Time-weighted average of current and next years consensus earnings estimates. Numbers above time line are annual growth rates. Source: Thomson Financial. Figure 34. S&P OPERATING EARNINGS PER SHARE (analysts average forecasts, ratio scale) Consensus Forecasts -month forward* Annual estimates Actual 4Q sum * Time-weighted average of current and next year s consensus earnings estimates. Numbers above time line are annual growth rates. Source: Thomson Financial. Page 2 / tember 2, 9 / Strategist s Handbook

29 - S&P /4/6 Squiggles: Weekly Figure 3. S&P OPERATING EARNINGS PER SHARE (analysts average forecasts, ratio scale) Consensus Forecasts 2-week forward* Annual estimates 9/ S&P 4 MIDCAP OPERATING EARNINGS PER SHARE (analysts average forecasts, ratio scale) /2 4 4 Consensus Forecasts week forward* Annual estimates S&P 6 SMALLCAP OPERATING EARNINGS PER SHARE (analysts average forecasts, ratio scale) /2 Consensus Forecasts 1 2-week forward* 3 Annual estimates * Time-weighted average of current and next years consensus earnings estimates. Source: Thomson Financial. 1 Page 26 / tember 2, 9 / Strategist s Handbook

30 Forward earnings is a good leading indicator of operating earnings except during downturns S&P Forward Earnings - Figure 36. S&P EARNINGS PER SHARE: FORWARD & ACTUAL (dollars) S&P Earnings Per Share Forward Earnings* Operating Earnings (4-quarter sum) * 2-week forward consensus expected S&P operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Monthly through April 1994; weekly thereafter. Source: Thomson Financial. Figure 37. S&P EARNINGS PER SHARE: FORWARD & ACTUAL (dollars) S&P Earnings Per Share Forward Earnings* (pushed 2-weeks ahead) Operating Earnings (4-quarter sum) * 2-week forward consensus expected S&P operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Monthly through April 1994; weekly thereafter. Source: Thomson Financial. 9/2 9/ Page 27 / tember 2, 9 / Strategist s Handbook

31 S&P forward earnings is highly correlated with business sales Figure 3. S&P FORWARD EARNINGS PER SHARE & BUSINESS SALES S&P Forward Earnings* (weekly, dollars per share) Business Sales** (billion dollars, saar) * 2-week forward consensus expected S&P operating earnings per share. Monthly through March 1994, weekly thereafter. Time-weighted average of current and next year s consensus earnings estimates. ** Manufacturing and trade sales. Source: Thomson Financial and US Department of Commerce, Bureau of the Census Forward Earnings & Sales - Figure 39. S&P FORWARD EARNINGS & BUSINESS SALES (yearly percent change) Jul 9/ S&P Forward Earnings* (weekly) Business Sales** Jul 9/ * 2-week forward consensus expected S&P operating earnings per share. Monthly through March 1994, weekly thereafter. Time-weighted average of current and next year s consensus earnings estimates. ** Manufacturing and trade sales. Source: Thomson Financial and US Department of Commerce, Bureau of the Census. Page 2 / tember 2, 9 / Strategist s Handbook

32 Forward Earnings & Orders - Figure 4. S&P FORWARD EARNINGS & FACTORY ORDERS S&P Forward Earnings* (weekly) Total New Factory Orders (trillion dollars, saar) S&P forward earnings is highly correlated with new factory orders and shipments * 2-week forward consensus expected S&P operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Monthly through April 1994; weekly thereafter. Source: Thomson Financial and US Department of Commerce, Bureau of the Census. Figure 41. S&P FORWARD EARNINGS & ORDERS 9/2 Jul S&P Forward Earnings* (weekly) 9.2 Total New Factory Shipments (trillion dollars, saar) Total New Factory Shipments Excluding Petroleum & Coal Products (trillion dollars, saar) 9/ Jul * 2-week forward consensus expected S&P operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Monthly through April 1994; weekly thereafter. Source: Thomson Financial and US Department of Commerce, Bureau of the Census. Page 29 / tember 2, 9 / Strategist s Handbook

33 Aerospace & Defense forward earnings and aircraft shipments tend to have same trends. - Forward Earnings: Industrial Shipments Figure 42. S&P FORWARD EARNINGS & SHIPMENTS: AEROSPACE & DEFENSE S&P Forward Earnings: Aerospace & Defense* Aug Total Aircraft Shipments (-month sum, billion dollars, saar) * Time-weighted average of current and next year s consensus estimates. Source: Census Bureau and Thomson Financial. 9 9 Figure 43. S&P FORWARD EARNINGS & SHIPMENTS: CONSTRUCTION & FARM MACHINERY & HEAVY TRUCKS Construction & Farm Machinery & Heavy Trucks forward earnings highly correlated with total shipments of these three industries S&P Forward Earnings: Construction & Farm Machinery & Heavy Trucks* Shipments** (billion dollars, saar) Jul * Time-weighted average of current and next year s consensus earnings estimates. ** Shipments include farm machinery, construction machinery and heavy duty trucks. Source: US Department of Commerce, Bureau of the Census and Thomson Financial. Page 3 / tember 2, 9 / Strategist s Handbook

34 Good correlation between Machinery shipments and Industrial Machinery forward earnings. - Forward Earnings: Industrial Shipments Figure 44. S&P FORWARD EARNINGS & SHIPMENTS: INDUSTRIAL MACHINERY S&P Forward Earnings: Industrial Machinery* Machinery Shipments (billion dollars, saar, 3-ma) Aug * 2-week consensus expected S&P operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Source: Thomson Financial and Bureau of the Census Figure 4. S&P FORWARD EARNINGS & SHIPMENTS: ELECTRICAL COMPONENTS & EQUIPMENT 3 Good correlation between forward earnings of Electrical Components & Equipment and shipments of Electrical Equipment S&P Forward Earnings: Electrical Components & Equipment* Electrical Equipment Shipments (billion dollars, saar, 3-ma) Aug 1 * 2-week consensus expected S&P operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Source: Thomson Financial and Bureau of the Census. Page 31 / tember 2, 9 / Strategist s Handbook

35 Tech forward earnings and shipments have bottomed. Semiconductor shipments extremely volatile. They may be bottoming Figure 46. S&P FORWARD EARNINGS & SHIPMENTS: INFORMATION TECHNOLOGY S&P Forward Earnings: Information Technology* Manufacturers Shipments: High Tech** (billion dollars, saar) * -month forward consensus expected operating earnings per share for the S&P Information Technology sector. ** Computers and electronic products, which include computers and related products, communications equipment, and semiconductors. Source: Thomson Financial and US Department of Commerce, Bureau of the Census Forward Earnings: IT & Semis - Figure 47. S&P FORWARD EARNINGS & SHIPMENTS: SEMICONDUCTORS Aug S&P Forward Earnings: Semiconductors* Shipments: Semiconductors (billion dollars, saar) * -month forward consensus expected operating earnings per share for the S&P Semiconductors industry. Source: Thomson Financial and US Department of Commerce, Bureau of the Census. Page 32 / tember 2, 9 / Strategist s Handbook

36 - Forward Earnings: Semi Equipment Figure 4. S&P FORWARD EARNINGS & BOOKINGS: SEMICONDUCTOR EQUIPMENT Forward Earnings* Bookings (billion dollars, saar, 3-ma) Aug 1 Semi equipment orders and forward earnings are highly correlated and very cyclical. Industry s stock price index tends to lead bookings * Dollars per share. Time-weighted average of current and next year s consensus earnings estimates. Source: Semiconductor Equipment and Materials International and Thomson Financial. Figure 49. SEMICONDUCTOR EQUIPMENT: STOCK PRICES & BOOKINGS (yearly percent change) Bookings Stock Price Index - Aug Source: Semiconductor Equipment and Materials International and Standard & Poor s Corporation. - Page 33 / tember 2, 9 / Strategist s Handbook

37 Materials forward earnings tends to move with industrial commodity prices. - Forward Earnings: Materials & Energy Figure. S&P FORWARD EARNINGS & PRICES: MATERIALS S&P Forward Earnings: Materials* CRB Raw Industrials Spot Price Index (weekly) / * -month forward consensus expected operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Source: Thomson Financial and Commodity Research Bureau. In July, the world s consumers of oil paid $1,926 billion (at an annual rate), down from a peak of $3,932 billion during July Figure 1. S&P FORWARD EARNINGS & WORLD CRUDE OIL OUTLAYS* (REVENUES) S&P Forward Earnings: Energy** Total World Crude Oil Revenues (billion dollars) Jul * Total world daily crude oil demand multiplied by 36 days and by the US average import crude oil price. ** -month forward consensus expected operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. Source: Energy Intelligence Group, "Oil Market Intelligence" and Thomson Financial. Page 34 / tember 2, 9 / Strategist s Handbook

38 - Forward Earnings: Energy - 4 Figure 2. S&P FORWARD EARNINGS & INTERNATIONAL RIG COUNT 9 This industry s forward earnings plunged along with world rotary rig count, but may be bottoming. 3 3 S&P Forward Earnings: Oil & Gas Drilling* Total World Rotary Rig Count Aug * Time-weighted average of current and next year s consensus earnings estimates. Source: Thomson Financial and Baker Hughes Figure 3. S&P FORWARD EARNINGS & SHIPMENTS: OIL & GAS EQUIPMENT SERVICES 4 44 Oil & Gas Equipment forward earnings bottoming S&P Forward Earnings: Oil & Gas Equipment & Services* Mining, Oil Field & Gas Field Machinery Shipments (3-ma, billion dollars, saar) Jul Aug * 2-week consensus expected S&P operating earnaings per share. Time-weighted average of current and next year s consensus earnings estimates. Source: Thomson Financial and Bureau of the Census. Page 3 / tember 2, 9 / Strategist s Handbook

39 - Forward Earnings: Diversified Banks - Figure 4. S&P BANKS EARNINGS & YIELD CURVE 3 4 S&P Diversified Banks Forward Earnings* (yearly percent change) Aug Yield Curve** - Yield curve and credit-quality spread are key drivers of Diversified Banks earnings growth * -month forward consensus expected operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. ** 1-year Treasury yield less the federal funds rate. Source: Thomson Financial and the Board of Governors of the Federal Reserve System Figure. S&P FORWARD EARNINGS & CORPORATE BOND SPREAD: FINANCIALS S&P Forward Earnings: Diversified Banks* (yearly percent change) A-Rated Corporate Bond Yield** Less 1-Year Government Bond Yield (inverted scale, basis points) * -month forward consensus expected operating earnings per share. Time-weighted average of current and next year s consensus earnings estimates. ** Moody s Corporate A monthly through 197, then weekly through. Beginning in 6 S&P Corporate A. Source: Moody s Investors Service, Thomson Financial, and the Board of Governors of the Federal Reserve System. 9/ Page 36 / tember 2, 9 / Strategist s Handbook

40 Figure 6. P/E RATIOS FOR S&P - Valuation: P/E Ratios - Using S&P forward earnings* Using 4-quarter trailing reported earnings * Price divided by -month forward consensus expected operating earnings per share using mid-month data. Monthly data through April 1994, weekly thereafter. 9/ US EQUITY MARKET CAPITALIZATION: NONFINANCIAL CORPORATIONS (as a ratio of NFC after-tax profits from current production*) NFC P/E S&P Trailing P/E** S&P Average P/E = * Including IVA and CCadj. These two adjustments restate the historical cost basis used in profits tax accounting for inventory withdrawals and depreciation to the current cost measures used in GDP. ** Using four-quarter trailing reported earnings. US EQUITY MARKET CAPITALIZATION EXCLUDING FOREIGN ISSUES As a ratio of: After-tax profits from current production* (Avg = 13.) Corporate Cash Flow** (Avg = 9.1) * Including IVA and CCadj. These two adjustments restate the historical cost basis used in profits tax accounting for inventory withdrawals and depreciation to the current cost measures used in GDP. ** After-tax operating retained earnings plus tax-return-based depreciation. Source: Thomson Financial, U.S. Department of Commerce, Bureau of Economic Analysis, Federal Reserve Board Flow of Funds Accounts, and Standard & Poor s Corporation Page 37 / tember 2, 9 / Strategist s Handbook

41 4 Figure 7. - Valuation: P/E & q - P/E RATIOS FOR S&P (using -month forward earnings*) 4 P/E measures are down sharply from 1999/ peaks. Prior to 199, Tech usually traded at roughly the same P/E as the overall market. It is doing so again recently S&P Technology Ex Technology * Price divided by -month forward consensus expected operating earnings per share using mid-month data. Data from 199 based on Global Industry Classification Standard. Source: Thomson Financial. 3. Figure. TOBIN S q FOR NONFINANCIAL CORPORATIONS* (ratio) 3. Tobin s q has limited value as a stock valuation model, although it did indicate significant overvaluation during the late 199s Actual q Adjusted q** * Ratio of market value of equities to net worth at market value, which includes real estate at market value and equipment, software, and inventories at replacement cost. ** Actual divided by average since 192. Source: Federal Reserve Board Flow of Funds Accounts. Page 3 / tember 2, 9 / Strategist s Handbook

42 - Valuation: SVM-1-6 Figure 9. STOCK VALUATION MODEL #1 (SVM-1)* (weekly, percent) 6 4 Overvalued Undervalued 9/ * Ratio of S&P Index to its fair value (2-week forward consensus expected S&P operating earnings per share divided by the 1-year US Treasury bond yield minus ). Monthly through April 1994, weekly thereafter. - 4 FORWARD P/E & BOND YIELD (SVM-1) (weekly) Ratio Of S&P Price To Expected Earnings* Bond s P/E=Reciprocal Of 1-Year US Treasury Bond Yield 9/ / * 2-week forward consensus expected S&P operating earnings per share. Monthly through March 1994, weekly thereafter MARKET S ESTIMATE OF EARNINGS (SVM-1) (weekly, dollars per share) S&P Forward Earnings Market s Estimate* Analysts Estimate** * S&P index multiplied by 1-year government bond yield. Monthly through March 1994, weekly thereafter. ** -month forward consensus expected S&P operating earnings per share. Monthly through March 1994, weekly thereafter. Source: Standard & Poor s Corporation and Thomson Financial. 9/2 9/ Page 39 / tember 2, 9 / Strategist s Handbook

43 - Valuation: SVM Figure 6. STOCK VALUATION MODEL #2 (SVM-2)* (percent) Overvalued 2-2 Undervalued Aug * Ratio of S&P index to its fair value (-month forward consensus expected S&P operating earnings per share divided by the difference between Moody s A-rated corporate bond yield less fraction [.1] of -year consensus expected earnings growth) STOCK VALUATION MODEL (SVM-2) (ratio scale) Actual S&P Fair Value S&P * -year earnings growth weight Aug * Fair value is -month forward consensus expected S&P operating earnings per share divided by the difference between Moody s A-rated corporate bond yield less fraction (as shown above) of -year consensus expected earnings growth ADDITIONAL VARIABLES IN SVM-2 Corporate A-rated yield* less 1-year Treasury yield.1 times Long-term consensus expected earnings growth *Moody s Corporate A monthly through 197, then weekly through. Beginning in 6 S&P Corporate A. Source: Moody s Investors Service and Thomson Financial. 9/ Page 4 / tember 2, 9 / Strategist s Handbook

44 This is another valuation model that compares the earnings yield to the real, rather than nominal, bond yield Figure 61. S&P EARNINGS YIELD & REAL BOND YIELD 1-year US Treasury Bond Yield Minus Average Expected CPI Inflation Rate For Next 1 Years (Phili Fed Survey)* S&P Expected Earnings To Price Ratio** 1-Year TIPS Yield*** (weekly) * Data from 1979 to 1991 quarterly, monthly thereafter. ** Earnings-price ratio is based on the Thomson Financial consensus estimates of earnings over the coming months. *** Yields on Treasury inflation protected securities (TIPS) adjused to constant maturities. Source: Board of Governors of the Federal Reserve System, US Treasury, Thomson Financial, and Federal Reserve Bank of Philadelphia Valuation: Equity Risk Spread - Figure 62. S&P EARNINGS YIELD MINUS REAL BOND YIELD* Aug 9/ * S&P forward expected earnings to price ratio minus 1-year Treasury bond yield minus average expected CPI inflation rate for next 1 years (Phili Fed Survey). Source: Board of Governors of the Federal Reserve System, US Treasury, Thomson Financial, and Federal Reserve Bank of Philadelphia. Page 41 / tember 2, 9 / Strategist s Handbook

45 - Valuation: Rules of 2-2 Figure RULE OF 2: P/E VS BOND YIELD 26 The "Rule of 2": The market s forward P/E has often traded around 2 minus the 1-year Treasury bond yield S&P Price to Expected Earnings Ratio* (dotted line) 9/ Minus 1-Year US Treasury Bond Yield (solid line) * Using four-quarter trailing reported earnings per share from 196 to tember 197. Then -month forward consensus expected S&P operating earnings per share from October 197 through March 1994, weekly after. Note: Shaded areas are periods when S&P fell % or more. Source: Thomson Financial and Board of Governors of the Federal Reserve System. Figure 64. CONSUMER PRICE INDEX (yearly percent change) PLUS S&P FORWARD P/E 3 Another "Rule of 2" is that stocks are overvalued (undervalued) when CPI inflation rate plus S&P forward earnings yield is greater than (less than) Stocks Overvalued 2 2 Stocks Undervalued Aug Source: Thomson Financial and US Department of Labor, Bureau of Labor Statistics. 1 Page 42 / tember 2, 9 / Strategist s Handbook

46 Figure 6. - Valuation: Bond Yield - BOND YIELD & NOMINAL GDP 1-Year Government Bond Yield (percent, average = 7.1%) GDP (yearly percent change, average = 7.4%) This simple bond model compares the yield to the growth in nominal GDP Source: US Department of Commerce, Bureau of Economic Analysis, and Board of Governors of the Federal Reserve System. Figure 66. BOND YIELD & NOMINAL GDP* average = plus 246 basis points average = minus 269 basis points average = -3 plus 1 basis points * 1-year bond yield minus yearly percent change in nominal GDP. Source: US Department of Commerce, Bureau of Economic Analysis, and Board of Governors of the Federal Reserve System. Page 43 / tember 2, 9 / Strategist s Handbook

47 Forward earnings for S&P, S&P 4, and S&P 6 bottomed earlier this year Figure Valuation: Market Cap - S&P FORWARD EARNINGS PER SHARE (weekly, Jan 1999=) Forward Earnings* S&P LargeCap S&P 4 MidCap S&P 6 SmallCap / * 2-week forward consensus expected operating earnings per share. Time-weighted average of the current year s and next year s consensus forecast. Source: Thomson Financial. Forward P/Es up sharply from lows Figure 6. P/E RATIOS FOR S&P INDEXES* (weekly) S&P LargeCap S&P 4 MidCap S&P 6 SmallCap / * Price divided by 2-week forward consensus expected operating earnings per share. Source: Thomson Financial. Page 44 / tember 2, 9 / Strategist s Handbook

48 - Market Cap Figure 69. US EQUITY MARKET CAPITALIZATION (trillion dollars) Market Value Total Excluding Foreign Issues S&P (weekly) / The value of stocks is rebounding. Source: Standard & Poor s Corporation and Federal Reserve Board Flow of Funds Accounts Figure 7. WILSHIRE INDEX (daily, 1/2/ = 17.9) / Source: Wilshire Associates. Page 4 / tember 2, 9 / Strategist s Handbook

49 - S&P Sector Shares - 3 Figure 71. S&P SECTORS (as a percent of total S&P market capitalization, weekly) Consumer Staples + Consumer Discretionary Health Care Financials Industrials 9/ Information Technology + Telecommunications Services Information Technology Telecommunications Services / /23 Energy Utilities Materials Source: Standard & Poor s Corporation Page 46 / tember 2, 9 / Strategist s Handbook

50 2 Figure 72. CONSUMER DISCRETIONARY (percent) - S&P Sector Shares - INDUSTRIALS Capitalization Share Earnings Share* CONSUMER STAPLES INFORMATION TECHNOLOGY ENERGY MATERIALS FINANCIALS TELECOMMUNICATIONS SERVICES HEALTH CARE UTILITIES * Using consensus -month forward earnings forecasts. May 3 swings attributable mostly to index composition changes. Source: Thomson Financial. 2 1 Page 47 / tember 2, 9 / Strategist s Handbook

51 - S&P /4/6 YTD - All Sectors 4 2 Figure 73. S&P LargeCap S&P 4 MidCap S&P 6 SmallCap Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecom Services Utilities Jan Feb Mar Apr May Jun Jul Aug Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Oct Nov Dec 9 Page 4 / tember 2, 9 / Strategist s Handbook

52 - S&P Sectors Total Forward Earnings Figure 74. CONSUMER DISCRETIONARY (billions of dollars) INDUSTRIALS CONSUMER STAPLES INFORMATION TECHNOLOGY ENERGY MATERIALS FINANCIALS TELECOMMUNICATION SERVICES HEALTH CARE UTILITIES Source: Thomson Financial. Page 49 / tember 2, 9 / Strategist s Handbook