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Issue No. 46 –October 3, 2005 Prescott, Arizona Systems@WiserTrader.com
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1.0 Trading
Over the past three weeks results were presented showing the individual effects of year ago price to earnings ratio (PE), year ago price to book ratio (PB) and year ago price to sales ratio (PS) on current stock prices one year later. The analysis series continues with the effect that year ago return on equity (ROE) has had on one year price performance.
1.1 ROE
The analysis again involved NYSE, NASDAQ and AMEX stocks that had earnings and were priced above $4. The study eliminated Advanced Depository Receipts, Over the Counter Stocks and Exchange Traded Funds. Since more information was available than for the previous price studies, the result this time was the slightly larger group of 3607 stocks shown in Figure 1. The chart on the left strangely implies an inverse relationship between ROE and 52 week price gain.
FIGURE 1
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As is typical for such data, the zoomed in chart on the right shows that for low values of ROE, one could have obtained a wide range of possible outcomes.
The 3,607 stocks were sorted into seven ROE ranges and used to plot 52 week price gain histograms. The data is summarized in Figure 2. Market data for the past year shows that the probability of minimal price gains of 25% or less is 60 to 70%, nearly independent of ROE. The higher the value of ROE, the greater the probability of price gains of 25% or greater.
Unlike the pattern that was seen with extreme PE ranges (less than 10 and greater than 50), extreme ranges of PB (less than 1 and greater than 10) and PS values less than 0.5, values of ROE of 50 to 100% contained the predominant number of stocks with price gains of 50% to more than 100%. This is as one would expect.
FIGURE 2
The percentages of stocks in Figure 2 can be treated as probabilities of price gains for ROE ranges over the past year only. How investors evaluate stocks from year to year may go a long way to explain the annual change in the character of the market. Higher ROE values produced the highest price gains, as one might expect. However, the correlation is not as orderly as one might expect, perhaps due to sporadic use of ROE among investors. In fact different degrees of use by investors of measures of stock value such as PE, PB and PS may also explain why each has had a somewhat unique characteristic correlation with price behavior over the past year. Recently, many investors have abandoned buy and hold measures of value in favor of market timing measures of growth and momentum. The next two weeks will take a look at the effects of year ago EPS and sales growth rates.
2.0 Market Analysis
The market was absorbed this week by a concern that consumer spending would decrease as a result of higher energy prices, particularly gasoline, natural gas and home heating oil, and Fed comments that housing prices may be a bubble that will soon pop. While consumer confidence decreased, energy prices rose and home building decreased. Still energy is only 6% of consumer spending and home building remains near record levels. It is also noteworthy that earnings warnings have been limited compared to previous quarters. Because of this, and it is a cautionary note, earnings expectations for the S&P 500 in the third quarter may be a little optimistic at 18%, as compared with 12% for the first half of the year.
Figure 3 compares index tracking stocks for the major averages with Sector SPDR’s.
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FIGURE 3
In Table 2A, the broader market edged upward for the week. Key industry ETF’s in Table 2A are Biotech and Semiconductors which confirm the NASDAQ. Transportation confirms the Dow Jones Industrial Average according to Dow Theory. Banking and Financials are confirming indicators for the S&P 500. Gold and Real Estate are respective indicators for the inverse health of the currency and consumer spending.
Table 2A
Index Tracking Stocks, Key Industry ETF’s and Sector SPDR’s
|
|
1 month |
1 wk ago |
2 wks ago |
3 wks ago |
4 wks ago |
|
DIA (DOW) |
1.1% |
1.6% |
-2.0% |
-0.5% |
2.1% |
|
QQQQ (NASDAQ 100) |
1.8% |
1.8% |
-1.6% |
-0.6% |
2.2% |
|
SPY (S&P 500) |
0.6% |
1.3% |
-1.7% |
-0.9% |
1.9% |
|
IWM (Russell 2000) |
0.3% |
1.9% |
-2.6% |
-0.7% |
1.8% |
|
GLD, GOLD |
5.5% |
0.9% |
1.0% |
2.2% |
1.3% |
|
RKH, Banking |
-2.9% |
-0.9% |
-2.8% |
0.1% |
0.8% |
|
IYT, Transportation |
2.2% |
3.1% |
-0.5% |
0.5% |
-0.9% |
|
SMH, Semiconductors |
1.3% |
2.0% |
-1.9% |
-1.2% |
2.4% |
|
BBH, Biotechnology |
-3.0% |
-0.9% |
-3.0% |
-0.8% |
1.7% |
|
IYR, Real Estate |
-1.4% |
2.5% |
-4.2% |
-1.0% |
1.4% |
|
OIH, Oil |
5.0% |
3.3% |
0.4% |
-1.5% |
2.7% |
|
XLE, Energy |
5.3% |
2.1% |
0.5% |
-1.0% |
3.6% |
|
XLU, Utilities |
1.8% |
2.8% |
-2.7% |
0.5% |
1.3% |
|
XLB, Materials |
0.0% |
1.6% |
-2.7% |
-0.6% |
1.8% |
|
XLI, Industrial |
1.3% |
1.4% |
-1.2% |
-0.4% |
1.6% |
|
XLK, Technology |
0.8% |
1.6% |
-2.0% |
-0.3% |
1.5% |
|
XLV, Healthcare |
-0.8% |
-0.4% |
-1.7% |
-1.3% |
2.5% |
|
XLF, Financials |
0.1% |
0.6% |
-2.0% |
0.3% |
1.3% |
|
XLP, Consumer Staples |
0.9% |
2.4% |
-1.5% |
-1.2% |
1.2% |
|
XLY, Consumer Discretionary |
-1.7% |
0.6% |
-2.6% |
-2.0% |
2.3% |