Market Analysis

As well as understanding expectations for sales growth in markets around the globe as we did in this post, another instrument in the AFG toolkit which sets AFG research apart is its ability to help clients determine key country and sector allocation decisions based on valuation, corporate performance, and economic momentum of a country and sector. Allocation Strategies have been increasingly important for investment managers given the changing investment landscape and focus on additional ways other than stock picking to gain alpha. Traditional allocation models are more qualitative in nature and are very difficult to trust with consistency. They are also focused on more macro indicators often failing to help investors understand the fundamentals of a given country or sector. For this reason, The Applied Finance Group has developed a multi-factor model using their Economic Margin Methodology, Valuation Model, and Economic Momentum to select the most attractive countries and recommending which sectors within the U.S. to over and underweight monthly.

We developed a hurdle rate for each company to understand which companies have high expectations that will be difficult to meet or exceed as well as companies with reasonable and low expectations for revenue growth relative to what they have delivered over the past five years. The data is then aggregated to determine the average "hurdle rate" for the index. At present, the S&P 500 index appears to be fairly valued. Current prices suggest that the market expects sales growth of 9.7% over the next five years. Compare this to the 5-year historical median sales growth of 7.3%. While the embedded expectations are reasonable given what the index has achieved in recent years, do not expect to find stocks at bargain-basement prices.

With 2010 nearing its end, it is a good time to revisit some of the predictions that were made by the participants of our professional investment survey The Market Forecast Project (MFP) at the beginning of the year to see how some of them turned out. The MFP survey was designed to provide investors an inside perspective into the minds of a large group of financial professionals to gain an edge via participation on important topics and stock picking. Those who participate receive the results as well as some of the favorite stock picks (long/short) from the pros before they are released to the media. The questions on this survey shine a light on professional investor opinions on everything from the state of the markets and economy, political events, commodity prices and timely events in the world of finance.

• Singapore Bourse Said to Bid $8.2 Billion for Australia's ASX – Bloomberg • Weak dollar is no strategy for economic growth – Fortune • FDA rejects Arena Pharma diet drug lorcaserin – Yahoo Finance • HP selling Windows 7 tablet for business users - AP • Is your rent too damn high? – WSJ • Wells Fargo reports record profit – Bloomberg

• Verizon to begin selling I-Pads • Apple shares rise above $300 before earnings • Chinese imports widen US trading gap • All 33 trapped Chilean miners rescued • Declining dollar boosts commodity rally • Long recovery looks like recession • Home Foreclosure moratorium won’t help anyone • Google is back! Jumps 11% on Friday – Barron’s

In case you missed it… • The “New Normal”, Not Necessarily Slow Growth • Illegal Immigration Allegations Hit California Gubernatorial Candidate Whitman (R) • Americans Warned About Travel To Europe After Terror threat • Sanofi Begins $18.5 Billion Hostile Offer for Genzyme • U.S. Still Adding Jobs….. Slowly • Gold Hits Record High…. Silver 30 Year High • Groupon Vs. Open Table: Online Coupon Competitors

Mining giant BHP Billiton (NYSE:BHP) is likely to end up over-paying for Canadian firm Potash (NYSE:POT), Rafael Resendes, co-founder of Applied Finance Group, told CNBC Thursday.

In 1963, business for American Express was booming: half a billion dollars of traveler’s checks were in circulation and over one million people had American Express cards. Then, scandal hit. An Amex warehouse subsidiary had issued receipts to Allied Crude Vegetable Oil Refining for bogus tanks of salad oil. The receipts were used to obtain loans on which Allied subsequently defaulted. When the creditors came to seize their collateral, the bogus tanks were exposed. While perhaps not legally bound, American Express assumed moral responsibility and was on the hook for $150 million – more cash than the company had on hand. Following the incident, American Express stock fell from $60/share to $35. As Amex’s share price fell, a little-known (at the time) investment manager named Warren Buffet purchased approximately 5% of the company. After determining that the scandal had no negative impact on cardholders’ propensity to use their Amex charge cards, Buffet concluded that the “salad oil scandal” was a one-time event from which the company could easily recover. His conviction was strong – at one point American Express accounted for more than 40% of his portfolio.

An explanation of the key questions a proper performance measure should answer along with some of the shortfalls of relying on basic performance metrics such as EPS. The subsequent installments of this series will discuss the pitfalls with ROE (Return on Equity) as a performance metric, RONA (Return on Net Assets), and IRR (Internal Rates of Return) type metrics. The series will conclude with a look at more economic based metrics and discuss why Economic Margin is ultimately the preferred approach to understand and measure a company’s performance.

Mr. Bronchick discusses the historical evidence that suggests that stocks nearly always outperform bonds and his prediction that “equities as an asset class will outperform investment grade bonds of almost any stripe over the intermediate and longer term using January 2010 as our starting point, and we would be willing to take side bets on the near term”.

Mr. Robinson discusses in his quarterly newsletter some of the macro-economic challenges that the U.S. currently faces. He also discusses his firm’s investment strategy of “relying on strong balance sheets and attractive valuations to minimize the risk of purchasing power loss while maximizing total return”.

Provides insight into AFG's screening process, and shows step-by-step instructions on how to run a screen using proprietary AFG variables. This article also highlights what the variables are, why they are important, and share back-test results for each of the variables. Clients of the Applied Finance Group have access to these variables on AFGView.com to screen and build charts, as well as in our Excel Add-in to download and build custom reports.

Reports concerning unemployment and housing show economic conditions continued to worsen in the fourth quarter. While corporate profits (as measured by the S&P 500) have improved from the significant losses of -$23.25/share reported in the fourth quarter of 2008, they are nowhere near their peak annual rate of $85/share experienced between the third quarter of 2006 and the second quarter of 2007. Importantly, much of this improvement can be attributed to financial firms which, while repaying TARP funds, are at the same time receiving another (lightly-disguised) subsidy as they borrow from the government at a Fed Funds rate under 25bps and lend that money right back to the government at close to 4%. Yet, “the market” (the S&P 500 is at 1140 as we write) is up over 70% from its 666 March low.

In August 2009, The Applied Finance Group (AFG) explored the relationship between Valuation and Momentum variables. (The original article can be found here.) We wrote about an interesting observation of the S&P 500's performance between 9/1998 and 6/2009. We showed that strategies built around Valuation or Momentum variables had periods of outperformance and underperformance, but combining these variables led to fairly consistent outperformance, as well as better overall performance than the individual variables alone. The table below highlights S&P 500 returns for Valuation (AFG’s Percent to Target variable), Momentum (AFG’s EM Momentum variable), and Combination strategies.

Seeking to provide clarity as to the true meaning of inflation, the late Nobel Laureate Milton Friedman helpfully described it as "always and everywhere a monetary phenomenon." At first glance Friedman's definition is hard to improve on--from post-WWI Germany to the 1970s in the United States and modern-day Zimbabwe, inflation has always been a monetary symptom of collapsing currency values. The problem, however, is that Friedman was actually defining something quite different. In the monetarist model that he practiced, money growth beyond a pre-set point was inflation. Friedman's point was that money quantities themselves always told the inflationary tale. But did they?