MODEL ANALYSIS for December 31, 2006
VALUATION INDICATOR
I must say I was surprised when in October of this year, Bob revealed his 2007 S&P 500 earnings estimate of $87.75. The figure that Bob is using seemed like a huge leap from his prior 2006 estimate of $82 which was closer to his forecast of $79 that he started the year making. I wonder if Bob's forecast is a little high this time. If we use Bob's $87.75 figure and the present level of 1,418.30, we get a price-to-earnings ratio of just over 16. The FED model used by Ed Yardeni suggests a P/E of 21.23 would be fairly valued. If Bob is right on his earnings estimate and we get some modest multiple expansion, 2007 could easily see new all time highs in the S&P 500 with a P/E of 18! If the long bond rises to 5.55%, the FED model would suggest a P/E of 18 is reasonable. I can see why Bob would be bullish when the foundation of his model at this time is sanguine. I rate this indicator as bullish.
MONETARY POLICY
Bob looks at short term rates and real money supply growth in connection with the Monetary Policy Indicator of his timing model. Last month, Ben Bernanke stated that the money supply has become unreliable as a tool for forecasting inflation and growth. Still, it is a component of Bob's model so let's take a look at where it is now. Real seasonally adjusted growth in M-2 is showing a decent gain of 2.78%. This is due to, in part, the latest CPI number of 2.0%. I had written a few months ago that I felt the next two CPI reports would be noteworthy. My thinking was that the year-over-year comparisons would be easy since they spiked up in the post Katrina/Rita period due to higher energy prices. So now with lower oil costs we are showing minimal CPI increases. Real growth in M-2 is starting to look like it could provide some fuel for a growing economy. I don't see the FED changing short-term rates soon since they worked so hard to normalize them. The Core PCE came in December 22, 2006 at 2.2%. This is down from the previous report of 2.4%. Should future reports come in under 2%, we may be able to start looking for a cut in short-term rates from the FED. I see the monetary indicator as neutral.
ECONOMIC INDICATOR
The final third quarter GDP number came in at 2.0%. That was a slight disappointment since the preliminary figure was 2.2% a month earlier. The good news is this sluggishness gives the FED no cause to take action to slow the economy. As the first week of the New Year ends, all eyes will be on the employment report, particularly the closely followed nonfarm payrolls which will be announced on Friday. We shall have to grind this one out and see if growth has bottomed and will turn upwards into 2007. The fourth quarter advanced GDP report comes out January 31st. For now, I rate this indicator as bullish.
SENTIMENT INDICATOR
Analyzing sentiment is something that Bob added to his "model" after the poor performance he suffered in the 1987 to 1991 time frame. When I first recall him mentioning it, the primary data point was the Investors Intelligence four week moving average of Bulls/Bulls + Bears. That data point has been in the 50s for most of the summer through the correction which is a neutral reading. In mid-October, it bumped up into the 60s. It has been in the low 70s since mid-November and has been inching toward the mid-70s the past two weeks. The four-week moving average is now 73.32%. That is in Bob's caution zone. Conversely, the Put/Call ratio continues to show healthy levels of doubt. The 10-day is 0.94, while the 60-day is at 0.88. Though it is not part of Bob's model, the American Association of Individual Investors has been a more reliable sentiment measure at least this year, and is currently at 56.1% and the four week moving average is 54.02%. I would rate the sentiment indicator as bullish right now.
I believe that as time goes by, Bob has learned more about technical analysis and added other data points to this Indicator in an attempt to diversify and avoid mistakes. During the panic of autumn 1998, Bob started talking about other indicators such as the Put/Call ratio. It was also then he seemed to key in on market internals such as new highs/new lows, advance/decline, volume, etc. He liked to see the market make a bottom and then drift higher, then retest the low on lighter volume. The theory was that those that were going to sell already did and that only left buyers left to move the market. To my way of thinking, the Sentiment Indicator is BULLISH.
CONCLUSION
To summarize, I believe Bob Brinker's timing model is still Bullish with three bullish and one neutral indicators. With valuations so reasonable and the large increase in earnings estimates, I would say that Bob Brinker views the future as bright for the U.S. equity markets, but at the same time realizes corrections do happen. I don't think Bob would be panicked to see a correction take the S&P 500 back under 1300. In fact, I would expect Bob to see that as a buying opportunity.
Steve Thompson