What is the SP500 Worth?

S&P recently published its buyback report which provides details of money returned to shareholders via buybacks.

On a trailing 12 months to 30 September, 2011, SP500 companies have returned per share amounts $25.18 in dividends and $44.30 for a total of $69.48.  For the full year, I expect SP500 companies will have returned per share amounts $25.65 in dividends and $47.60 for a total of $73.25.  If we assume that SP500 companies can grow this value returned at a real growth rate of 2%, an investor who has a long term real rate of return expectation of 6.5%, should have been willing to buy the SP500 at 1,575 at end September and at 1,660 at end December, for this is the discounted value of future cash flows expected to be returned to shareholders.  There are 3 major problems with the calculation above; 

Europe: A Tail Risk No More

What is a tail risk?  Put simply, it is a future risk event that has a low likelihood of occurrence in the absence of sheer stupidity.  In Europe, we have seen sheer stupidity flow forth from Germany.  And that leads me to believe Europe is no longer a tail risk; it is a very real risk.

This week we saw Germany scoff at the immediate need to provide funding to IMF; we also heard that none might be provided if the rest of the world does not chip in.  We also saw Troika not closing on the Greek debt deal.  We also saw Monti pushing back.

Now Papademos and Monti are both technocrats.  And given that what Germany demands makes no sense; in the long term it is likely that they will conclude that it would be better to leave the EZ, gain control over their own currency, restructure their debt and move on.  The alternative imposed by Germany is far worse as it has a deeper depth to suffering and a longer duration too.

SP500 2012 Outlook

In Europe Storm clouds continue to gather.  A recession has likely already started.  In emerging economies, rates of growth have slowed down considerably.  In US Q3 GDP was first estimated at 2.5%.  The second estimate came in at 2%.  I expect the final estimate to come in at 1.5%.  Corporate America has started warning on expectations by giving initial signals of slowing growth during Q4 2011 and Q1 2012; the earnings downgrade cycle which is in an advanced stage in EM's is only just beginning in US.  A slow down in EM's and a recession in Europe more or less assure that US will enter recession during Q1/Q2 2012, if not in Q4 2011.  The fiscal drag from a potential loss of the stimulus provided from payroll tax cuts, could result in a sharp contraction, but if the payroll tax cuts are extended, any contraction could be fairly mild.

What Did the EU Summit Achieve?

Merkel rightly believes that Europe's problems will take years to solve; but she translates that into meaning that she has time to act. The luxury of time is just not there; if Italy or Spain go from being illiquid to being insolvent, the problems that are manageable today, become unmanageable. What is required, or rather desired, is something credible; something decisive; something substantial; something quick; something comprehensive. This was not achieved and so risks remain elevated. Something giving a few months or quarters visibility would help; but we remain in an environment where we watch the story unfold one day at a time. 

Sensex Upside Potential - 2012 Outlook

Fiscal Year 2011 (Year end 31/3/2011), earnings came in at 1,013.  Late last year, estimates for FY12 were centered around 1,275 and for FY13 at Rs 1,500.  Estimates have now been cut down to size; with FY12 estimates coming in at 1,125 plus or minus 50, and FY13 estimates coming in at 1,275, plus or minus 50.  And there is an expectation that this downgrade cycle will continue a while longer; for FY13 some like Bank of America are speaking of further downward revisions to 1,200.  In my view, just as there was too much optimism late in 2010, there is now too much pessimism built in to the numbers.  This opens up upside for FY13.

Good Week; What Next - Merkel Part of the Problem not the Solution

Markets moved up strongly.  But why? Nothing remotely resembling a solution for EZ came up. The waffling has just continued.  There is no progress; and what is worrying is that all solutions are clearly identified and on the table on which Merkel, Sarkozy and Monti dine. Merkel & Germany are clearly part of the problem not the solution; like a spoilt child she cries for treaty amendments as the only solution and accepts nothing else - a solution which does not buy time is no solution at all and while treaty amendments and debt reduction are the desired end outcome, in the interim a more proactive ECB and Stability Bonds are a must.

Global Central Banks responded to the rising TED Spread this past week; but TED continued to rise anyway.  Without something real on the table out of EZ we could see big trouble accompanying a spike from 53 bps to 75 bps initially and then higher as terror sets in.  A rising TED means a withdrawal of liquidity from markets; that is bad news for equity.  It also indicates fear of inter bank lending; this indicates a great degree of stress in the finacial system.  TED tends to be a very good short leading indicator of trouble; but it is quick to respond to changed circumstances, which means good policy could result in slowly narrowing spreads - that would be market positive.  When the TED spread is at 50 bps, a lot of very clever people are worried - you have to be watchful.  When TED spread is at 10 bps, a lot of very clever people are complacent, you got to be watchful.  In the middle, every mostly alright!

Risks have risen considerably; EZ bond yields and the TED spread need to be driven up, and equities need to fall sharply for markets to signal their lack of conviction and confidence in EZ policy.  And of course, gold and US-T as safehavens will rise.  That perhaps is the only thing which might force some policy action; and if it does not be prepared for a serious meltdown.

News in India over the week-end is possibly worrying with Mamta Banerjee claiming that Pranab Mukerjee has indicated that recent policy reform on FDI in retail is shelved pending consensus; see ET article here.

I wish Sarkozy and Monti had more influence in EZ, but they do not, for it would appear that the EZ is Germany.  I hope, that Geithtner will be able to offer insights and suggestions to EZ, but I doubt it; now a days Merkel hears only her own voice.

Bottom line, I think next week will be ugly, ugly, ugly.  Whether ugly evolves to a major meltdown depends on policy.  We remain at the mercy of policy makers and unfortunately they are not delivering.