21 October 2020
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Woodhall's February Wall Street connections

Ron Bewley
6 February 2012

Both the S&P 500 and the AXSX 200 enjoyed excellent returns during January. For a change, our index grew by 5.1 or 0.7 per cent better than the US. But these increases bring with them an erosion of the underpricing that was so prevalent during the second half of 2011. For the ASX 200, the market is now about fair priced with most sectors being close to that level. In the US, however, most sectors are a little overpriced. The S&P 500 is about two per cent over which is not alarming in itself but it might become a constraint soon.

We have argued that six per cent for exuberance can be the tipping point for a correction or an extended period of sideways movement. That would mean that another month of four per cent growth for the S&P 500 might stunt any further growth with a knock-on effect for the ASX 200.

Good longer-term growth is expected in both markets. For the next 12 months, the ASX 200 is expected to grow by 13.3 per cent, about three per cent faster than the S&P 500. Importantly, these rolling 12-months-ahead forecasts have strengthened during January. In the case of Australia, the gain has been two percentage points. (Stay tuned in coming weeks for Woodhall's Quant Quarterly which has more detail on the Australian market.)

Australian fear has been in the 'good zone' since 1 December 2011 (see Woodhall's Weekly for more details). The equivalent index for the S&P 500 has come down but retains some volatility. The VIX finished below 20 per cent for the first time since the August debt-ceiling debacle. Both markets are generally now reasonably calm.

The exchange-rate-corrected ASX 200 continued to lag behind the S&P 500 (Charts 16 & 17) although the gap has closed a fraction. It appears that the increased currency volatility from October 2011 may have broken this long-standing relationship.

The probabilities of default for both North America and Western Europe fell for both the one-year and five-year horizons. The European woes are having less impact on our fates.

The future seems to be more optimistic than at any time since June 2011 and maybe even earlier.

All data are sourced from Thomson Reuters Datastream.


Charts 1 and 2: Each point on each line represents a 12-month ahead forecast of total returns or dividends starting from the date on the horizontal axis. The forecasts are constructed from broker forecasts of dividends and earnings for each company in the index, then aggregated up to sectors and then to the market index. Thus, the first forecast on the left of each chart started twelve months ago and finishes today. The right hand point is for the next 12 months starting today. Since the S&P 500 forecasts were updated monthly until June 2011, the blue lines are horizontal between updates up until June 2011.


Charts 3 and 4: These charts are based on the information used to compile the forecasts for the most recent day by sector and market.


Charts 5, 6, 7 and 8: We take the forecasts of capital growth in Charts 2 and 4 to determine where the market should be priced. A necessary assumption of our method is that these forecasts are credible. The ratio of the actual price index to the point we estimate the market should be located measures mispricing. Charts 7 and 8 present the most recent data and, for reference, where mispricing was estimated to be one week earlier. We have previously determined that six per cent can be a useful indicator that the market or sector is sufficiently expensive to cause a correction or to stay flat while the fundamentals improve to eroded mispricing. We have never been able to establish a trading rule based on this indicator but it often serves to indicate good entry and exit points for long-term investors needing to rebalance a portfolio. We have also found that expensive markets tend to fall faster and further when our fear and disorder indexes are high. Conversely, cheap markets seem to stay cheap long when fear and disorder are high.

Charts 9, 10, 11 and 12: Historical and forward price-earnings ratios are similar to those usually calculated. However, we use the relevant earnings estimates to be those consistent with the ones we derive for use in our total returns forecasts. The main difference between our method and traditional methods is that we attempt to provide a timelier estimate of earnings for the current day and going forward.

Charts 13 and 14: The VIX index is the standard 'fear' index that is based on options pricing for the S&P 500. At Woodhall, we have defined a fear index that is based on recent intra-day movements in each of the price indexes. Our fear statistic is a measure of excess or irrational volatility. We have argued elsewhere that our fear index tends to lead the VIX and the Australian equivalent.

Charts 15, 16, 17 and 18: We have argued that it is sometimes useful to consider our ASX 200 index valued in US dollars to aid comparison with the S&P 500. By so doing, we compare our market as a fully-hedged US dollar investor would see us. The ratio of the two US-dollar-denominated indexes in Chart 17 serves as a potential mispricing signal. The Australian dollar measured in US dollars is shown in Chart 18 for reference.

Charts 19 and 20: The ratings agency Fitch analyses the probabilities of default for a variety of bonds in several regions of the world and combines them into regional index. Action by the debtor can change the outcome so that these probabilities are estimates of what might happen in the presence on inaction.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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