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Global

Equity Research

Deutsche Banc Alex. Brown Global Strategy August 13, 2001

Asset Valuation & Allocation Models

Dr. Edward Yardeni Chief Investment Strategist (+1) 212 469 5715 edward.yardeni@db.com Amalia F. Quintana Equity Strategy Analyst (+1) 212 469 5713 mali.quintana@db.com

Deutsche Bank


- Introduction I. Fed’s Stock Valuation Model How can we judge whether stock prices are too high, too low, or just right? The purpose of this weekly report is to track a stock valuation model that attempts to answer this question. While the model is very simple, it has been quite accurate and can also be used as a stocksversus-bonds asset allocation tool. I started to study the model in 1997, after reading that the folks at the Federal Reserve have been using it. If it is good enough for them, it’s good enough for me. I dubbed it the Fed’s Stock Valuation Model (FSVM), though no one at the Fed ever officially endorsed it. On December 5, 1996, Alan Greenspan, Chairman of the Federal Reserve Board, famously worried out loud for the first time about “irrational exuberance” in the stock market. He didn’t actually say that stock prices were too high. Rather he asked the question: “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions….”1 He did it again on February 26, 1997.2 He probably instructed his staff to devise a stock market valuation model to help him evaluate the extent of the market’s exuberance. Apparently, they did so and it was made public, though buried, in the Fed’s Monetary Policy Report to the Congress, which accompanied Mr. Greenspan’s Humphrey-Hawkins testimony on July 22, 1997.3 The Fed model was summed up in one paragraph and one chart on page 24 of the 25-page document (see following table). The chart shows a strong correlation between the S&P 500 forward earnings yield (FEY)—i.e., the ratio of expected operating earnings (E) to the price index for the S&P 500 companies (P), using 12-month-ahead consensus earnings estimates compiled by Thomson Financial First Call.—and the 10-year Treasury bond yield (TBY). The average spread between the forward earnings yield and the Treasury yield (i.e., FEY-TBY) is 29 basis points since 1979. This near-zero average implies that the market is fairly valued when the two are identical: 1)

FEY = TBY

Of course, in the investment community, we tend to follow the price-to-earnings ratio more than the earnings yield. The ratio of the S&P 500 price index to expected earnings (P/E) is highly correlated with the reciprocal of the 10-year bond yield, and on average the two have been nearly identical. In other words, the “fair value” price for the S&P 500 (FVP) is equal to expected earnings divided by the bond yield in the Fed’s valuation model:

1

http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm “We have not been able, as yet, to provide a satisfying answer to this question, but there are reasons in the current environment to keep this question on the table.” http://www.federalreserve.gov/boarddocs/hh/1997/february/testimony.htm 3 http://www.federalreserve.gov/boarddocs/hh/1997/july/ReportSection2.htm 2

Page 2 / August 13, 2001 / Deutsche Banc Alex. Brown US Stock Valuation & Allocation Models


2)

FVP = E/TBY

Excerpt from Fed’s July 1997 Monetary Policy Report: The run-up in stock prices in the spring was bolstered by unexpectedly strong corporate profits for the first quarter. Still, the ratio of prices in the S&P 500 to consensus estimates of earnings over the coming twelve months has risen further from levels that were already unusually high. Changes in this ratio have often been inversely related to changes in long-term Treasury yields, but this year’s stock price gains were not matched by a significant net decline in interest rates. As a result, the yield on tenyear Treasury notes now exceeds the ratio of twelve-month-ahead earnings to prices by the largest amount since 1991, when earnings were depressed by the economic slowdown. One important factor behind the increase in stock prices this year appears to be a further rise in analysts’ reported expectations of earnings growth over the next three to five years. The average of these expectations has risen fairly steadily since early 1995 and currently stands at a level not seen since the steep recession of the early 1980s, when earnings were expected to bounce back from levels that were quite low.

The ratio of the actual S&P 500 price index to the fair value price shows the degree of overvaluation or undervaluation. History shows that markets can stay overvalued and become even more overvalued for a while. But eventually, overvaluation is corrected in three ways: 1) falling interest rates, 2) higher earnings expectations, and of course, 3) falling stock prices—the old fashioned way to decrease values. Undervaluation can be corrected by rising yields, lower earnings expectations, or higher stock prices. The Fed’s Stock Valuation Model worked quite well in the past. It identified when stock prices were excessively overvalued or undervalued, and likely to fall or rise: 1) The market was extremely undervalued from 1979 through 1982, setting the stage for a powerful rally that lasted through the summer of 1987. 2) Stock prices crashed after the market rose to a record 34% overvaluation peak during September 1987. 3) Then the market was undervalued in the late 1980s, and stock prices rose. 4) In the early 1990s, it was moderately overvalued and stock values advanced at a lackluster pace. 5) Stock prices were mostly undervalued during the mid-1990s, and a great bull market started in late 1994. 6) Ironically, the market was actually fairly valued during December 1996 when the Fed Chairman worried out loud about irrational exuberance. Deutsche Banc Alex. Brown US Stock Valuation & Allocation Models / August 13, 2001 / Page 3


7) During both the summers of 1997 and 1998, overvaluation conditions were corrected by a sharp drop in prices. 8) Then a two-month undervaluation condition during September and October 1998 was quickly reversed as stock prices soared to a remarkable record 70% overvaluation reading during January 2000. This bubble was led by the Nasdaq and technology stocks, which crashed over the rest of the year, bringing the market closer to fair value.

II. New Improved Model The FSVM is missing a variable reflecting that the forward earnings yield is riskier than the government bond yield. How should we measure risk in the model? An obvious choice is to use the spread between corporate bond yields and Treasury bond yields. This spread measures the market’s assessment of the risk that some corporations might be forced to default on their bonds. Of course, such events are very unusual, especially for companies included in the S&P 500. However, the spread is only likely to widen during periods of economic distress, when bond investors tend to worry that profits won’t be sufficient to meet the debt-servicing obligations of some companies. Most companies won’t have this problem, but their earnings would most likely be depressed during such periods. The FSVM is also missing a variable for long-term earnings growth. My New Improved Model includes these variables as follows: 3)

FEY = CBY – b • LTEG

where CBY is Moody’s A-rated corporate bond yield. LTEG is long-term expected earnings growth, which is measured using consensus five-year earnings growth projections. I/B/E/S International compiles these monthly. The “b” coefficient is the weight that the market gives to long-term earnings projections. It can be derived as -[FEYCBY]/LTEG. Since the start of the data in 1985, this “earnings growth coefficient” averaged 0.1. Equation 3 can be rearranged to produce the following: 4)

FVP = E ÷ [CBY – b • LTEG]

FVP is the fair value price of the S&P 500 index. Exhibit 10 shows three fair value price series using the actual data for E, CBY, and LTEG with b = 0.1, b = 0.2, and b = 0.25. The market was fairly valued during 1999 and the first half of 2000 based on the consensus forecast that earnings could grow more than 16% per year over the next five years and that this variable should be weighted by 0.25, or two and a half times more than the average historical weight.

III. Back To Basics With the benefit of hindsight, it seems that these assumptions were too optimistic. But, this is exactly the added value of the New Improved FSVM. It can be used to make explicit the Page 4 / August 13, 2001 / Deutsche Banc Alex. Brown US Stock Valuation & Allocation Models


implicit assumptions in the stock market about the weight given to long-term earnings growth. The simple version has worked so well historically because the long-term growth component has been offset on average by the risk variable in the corporate bond market.

IV. Stocks Versus Bonds The FSVM is a very simple stock valuation model. It should be used along with other stock valuation tools, including the New Improved version of the model. Of course, there are numerous other more sophisticated and complex models. The Fed model is not a market-timing tool. As noted above, an overvalued (undervalued) market can become even more overvalued (undervalued). However, the Fed model does have a good track record of showing whether stocks are cheap or expensive. Investors are likely to earn below (above) average returns over the next 12-24 months when the market is overvalued (undervalued). The next logical step is to convert the FSVM into a simple asset allocation model (Exhibit 1 on front cover). I’ve done so by subjectively associating the “right� stock/bond asset mixes with the degree of over/under valuation as shown in the table below. For example, whenever stocks are 10% to 20% overvalued, I would recommend that a large institutional equity portfolio should have a mix with 70% in stocks and 30% in bonds.

Stocks/Bonds Asset Allocation Model More than 20% overvalued

60% stocks, 40% bonds

10% to 20% overvalued

70% stocks, 30% bonds

Less than 10% overvalued or undervalued

80% stocks, 20% bonds

10% to 20% undervalued

85% stocks, 15% bonds

More than 20% undervalued

90% stocks, 10% bonds

Deutsche Banc Alex. Brown US Stock Valuation & Allocation Models / August 13, 2001 / Page 5


#1 ED YARDENI’S ASSET ALLOCATION MODEL: STOCKS/BONDS (for large equity funds) Stocks overvalued when greater than zero Stocks undervalued when less than zero

60/40 70/30 8/10

80/20 80/20 85/15 90/10

yardeni.com 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02

* Ratio of S&P 500 index to it’s fair value (12-month forward consensus expected operating earnings per share divided by the 10-year US Treasury bond yield) minus 100. Monthly through March 1994, weekly after. Source: Thomson Financial

75 70 65 60 55 50 45 40 35 30 25 20 15 10 5 0 -5 -10 -15 -20 -25 -30 -35 -40

- Asset Allocation -

Page 6 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

75 70 65 60 55 50 45 40 35 30 25 20 15 10 5 0 -5 -10 -15 -20 -25 -30 -35 -40


- Valuation Model #2 1725 1575 1425 1275 1125 975

FED’S STOCK VALUATION MODEL (ratio scale) 8/10

1725 1575 1425 1275 1125 975

825

S&P 500 Price Index

825

675

Fair-Value Price*

675

525

525

375

375

225

225

yardeni.com

75

75

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

* 12-month forward consensus expected S&P 500 operating earnings per share divided by 10-year US Treasury bond yield. Monthly through March 1994, weekly after. Source: Thomson Financial

#3 70 60

70

FED’S STOCK VALUATION MODEL* (percent)

60

50

50

40

40

30

30

20

20

Overvalued

10

8/10

0

-10

Undervalued

-20

-30 -40

10 0

-10 -20

According to the Fed model, when stock prices are overpriced, returns from stocks are likely to be subpar over the next 12-24 months. Better-than-average returns tend to come from underpriced markets.

-30 yardeni.com

-40

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

* Ratio of S&P 500 Index to its Fair-Value (52-week forward consensus expected operating earnings per share divided by the 10-year US Treasury bond yield) minus 100. Monthly through March 1994, weekly after. Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 7


- Valuation Model #4 18

This chart appeared in the Fed’s July 1997 Monetary Policy Report to the Congress. It shows a very close correlation between the earnings yield of the stock market and the bond yield. Another, more familiar way to look at it follows.

18

S&P 500 EARNINGS YIELD & BOND YIELD

17

17

16

16

15

15

Forward Earnings Yield*

14

14

10-Year US Treasury Bond Yield

13

13

12

12

11

11

10

10

9

9

8

8

7

7

6

6

5

8/10

4

5 4

3

3 yardeni.com

2

2

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

* 12-month forward consensus expected S&P 500 operating earnings per share divided by S&P 500 Index. Monthly through March 1994, weekly after. Source: Thomson Financial

#5

The S&P 500 P/E (using expected earnings) is highly correlated with reciprocal of the bond yield.

26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5

P/E & BOND YIELD

Ratio of S&P 500 Price to Expected Earnings*

8/10

Fair-Value P/E=Reciprocal of 10-Year US Treasury Bond Yield

Jun Jul Jul Jul Jul Aug Aug

29 6 13 20 27 3 10

Actual 21.7 21.8 21.4 21.7 21.5 21.9 21.5

Fair 18.9 18.5 18.8 19.4 19.4 19.5 19.7 yardeni.com

26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

* 12-month forward consensus expected S&P 500 operating earnings per share. Monthly through March 1994, weekly after. Source: Thomson Financial

Page 8 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models


- Earnings #6 75

70

75

S&P 500 EARNINGS PER SHARE (analysts’ average forecasts) Consensus Forecast for 2001

70

Consensus Forecast for 2002

65

65

Forward Earnings* 60

60

8/10

Consensus Forecast for 2000

55

50

45

Expected forward earnings is a time-weighted average of current and the coming years’ consensus forecasts.

55

50

yardeni.com I

45 II

2000

III

IV

I

II

2001

III

* 52-week forward consensus expected S&P 500 operating earnings per share. Source: Thomson Financial

#7 65

65

S&P 500 EARNINGS PER SHARE: ACTUAL & EXPECTED

60

60

S&P 500 Earnings Per Share ________________________ 55 50 45

Forward Earnings* (pushed 52-weeks ahead)

Q1

8/9

55 50

Operating Earnings (4-quarter sum)

45

40

40

35

35

30

30

25

25

20

20

15

15

10

yardeni.com

Bottom-up 52-week forward expected earnings tends to be a good predicator of actual earnings, with a few significant misses.

10

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

* 52-week forward consensus expected S&P 500 operating earnings per share. Monthly through March 1994, weekly after. Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 9


- Earnings #8 75 70

75

S&P 500 CONSENSUS OPERATING EARNINGS PER SHARE (analysts’ bottom-up forecasts) Consensus Forecasts __________________

65

70

02

01

65

12-month forward Annual estimates

60

00

99

60

Actual 4Q sum 55 50

55 50

97 96

45 40 35

Jul

98

45 40

95 91

94

93

92

35

30

30

25

25 yardeni.com

20 1990

Analysts always start out too optimistic about the prospects for earnings.

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

20

2002

Source: yardeni.com. Do not reprint without permission.

#9 35

35

S&P 500 CONSENSUS OPERATING EARNINGS PER SHARE (analysts’ bottom-up forecasts, ratio scale)

30

30

Consenus Forecasts _________________

89

12-month forward 88

Annual estimates

25

Actual 4Q sum 82

90

85

86

25

87

83 84

20

20

81 80 15

15

10 1978

yardeni.com 1979

1980

1981

1982

1983

1984

1985

1986

1987

Source: yardeni.com. Do not reprint without permission.

Page 10 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

1988

1989

1990

1991

10


- Earnings #10 25

25

S&P 500 EARNINGS PER SHARE 8/10

20

15

20

15

Consensus Growth Forecasts* _______________

10

10

2001/2000 2002/2001

5

5

0

0

-5

-5 8/10

-10

yardeni.com

-15 I

II

2000

III

IV

I

II

2001

The data on consensus expected earnings can be used to derive consensus earnings growth forecasts.

-10

-15

III

* Based on consensus expected S&P 500 operating earnings for years shown. Source: Thomson Financial

#11 35 30

35

S&P 500 OPERATING EARNINGS PER SHARE* (yearly percent change)

30

Actual 25

25

Consensus Forecast (Proforma)* 20

20

15

15

10

10

5

5

0

Q4

0

-5

-5

-10

-10

-15

-15 yardeni.com

-20 1994

1995

1996

1997

1998

1999

2000

2001

Earnings growth is highly cyclical.

-20

2002

* S&P 500 composition is constantly changing. Actual data are not adjusted for these changes. Proforma forecasts are same-company comparisions. Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 11


- New Improved Model #12 2000

2000

NEW IMPROVED STOCK VALUATION MODEL

1800

1800

This New Improved 1600 Model builds on the 1400 simple one by adding variables for 1200 long-term expected earnings growth and 1000 risk.

1600

.25 S&P 500 Index Fair Value* 5-year earnings growth weight _____________ .25

1200 1000

.10

.20

800

Jul

.20

1400

800

.10 600

600

400

400

200

200 yardeni.com

0

0

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* Fair Value is 12-month forward consensus expected S&P 500 operating earnings per share divided by difference between Moody’s A-rated corporate bond yield less fraction (as shown above) of 5-year consensus expected earnings growth. Source: Thomson Financial

#13 30

Long-term earnings growth expectations rose sharply during 1990s. Now they are coming back down to the Planet Earth.

30

LONG-TERM CONSENSUS EARNINGS GROWTH* (annual rate, percent)

S&P 500 25

25

S&P 500 Technology Ex Technology 20

20

Jul

15

yardeni.com

10

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* 5-year forward consensus expected S&P 500 earnings growth. Source: Thomson Financial

Page 12 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

15

10


- New Improved Model #14 40

MARKET’S WEIGHT FOR 5-YEAR CONSENSUS EXPECTED EARNINGS GROWTH* (percent)

35

40

35

Weight market gives to long-term earnings growth ________________________________________ 30

30

value > 13% = more than average weight value < 13% = less than average weight

25

25

20

Jul

15

20

15

Average = 13%

10

10

5

5

0

0 yardeni.com

-5

Investors have on average over time subtracted 13% of their long-term earnings growth expectations from the corporate bond yield to determine earnings yield.

-5

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* Moodyâ&#x20AC;&#x2122;s A-rated corporate bond yield less earnings yield divided by 5-year consensus expected earnings growth.

#15 1.6

1.6

S&P 500 PEG RATIO

1.5

1.4

1.5

P/E ratio for S&P 500 divided by 5-year consensus expected earnings growth*

Jul

1.3

1.2

1.4

1.3

Average = 1.2

1.2

1.1

1.1

1.0

1.0

.9

.9

.8

yardeni.com

Historically, S&P 500 sold at P/E of 1.2 times long-term expected earnings growth, on average, with quite a bit of volatility.

.8

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* P/E using 12-month forward consensus S&P 500 expected earnings and prices at mid-month. Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 13


- New Improved Model #16 12

12

CORPORATE BOND YIELD (percent)

11

11

10

10

A-Rated

9

9

8

8 8/10

7

Corporate bond yield variable in New Improved Model captures risk that earnings will be weaker than expected.

7

yardeni.com

6

6

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* Source: Moody’s Investors Service

#17 300

250

300

CORPORATE SPREAD (basis points)

Moody’s A-Rated corporate bond yield minus 10-Year US Treasury bond yield

8/10

200

250

200

Average = 156 150

150

100

100

yardeni.com

50

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Source: Moody’s Investor Service

Page 14 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

50


- Global: Stock Valuation #18 80 60

80

UNITED STATES

60

Overvalued

40

40

20

Jul

0

0

-20

-20

Undervalued

-40

-40 1995

30

1996

1997

1998

1999

2000

2001 30

UNITED KINGDOM Overvalued

20

20

10

10

0

0

Undervalued

-10

Jul

-20

150

-10 -20

1995 200

20

1996

1997

1998

1999

2000

2001 200

JAPAN

150

100

100

Overvalued

50

50

0

0

-50

Undervalued

Jul

-100

-100 1995

80 60

1996

1997

1998

1999

2000

2001 80

GERMANY

60

Overvalued

40

40

20

20

0

Jul

-20

-40 1995

1996

1997

1998

1999

2000

2001 60

FRANCE

40

40

Overvalued

20

20 Jul

0

Undervalued

-20

0 -20

-40

-40 1995

50

0 -20

Undervalued

-40 60

-50

1996

1997

1998

1999

2000

2001 50

CANADA Overvalued

30

30

10

10 Jul

-10

-10

Undervalued

yardeni.com

-30 1995

1996

1997

1998

1999

2000

-30

2001

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 15


- Global: Expected Earnings* -

#19 65

UNITED STATES (S&P 500)

325

GERMANY (DAX)

300

60

Jul 275

Jul

55

250 50 45

225

Expected EPS* (dollars)

Expected EPS (euros)

200 175

40

150 35 125 30

100

25

550 525

75 89 90 91 92 93 94 95 96 97 98 99 00 01 02

89 90 91 92 93 94 95 96 97 98 99 00 01 02

CANADA (TSE 300)

FRANCE (CAC 40)

280 260

500

Jul 240

475 Jul

450 425

Expected EPS (euros)

Expected EPS (Canadian dollars)

220

400

200

375

180

350 160

325 300

140

275 120

250 225

360

100 89 90 91 92 93 94 95 96 97 98 99 00 01 02

89 90 91 92 93 94 95 96 97 98 99 00 01 02

UNITED KINGDOM (FT 100)

JAPAN (TOPIX)

70

340 60

320 300

Jul

Expected EPS (pounds)

Expected EPS (yen) Jul

280

50

260 40 240 220

30

200 yardeni.com

180 89 90 91 92 93 94 95 96 97 98 99 00 01 02

89 90 91 92 93 94 95 96 97 98 99 00 01 02

* 12-month forward consensus expected operating earnings per share. Source: Thomson Financial

Page 16 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

20


- Global: United States (S&P 500) -

#20 160

70

STOCK VALUATION MODEL

150 60 140

Jul

130

50

Industrial Production (1987=100)

120

40 110 100

30

90

Expected Earnings Per Share* For S&P 500 (dollars)

80

20

70

10 79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

30

30

25

25

Fair-Value P/E 20

20

Jul

Forward P/E

15

15

10

10

5

5 79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

1825 1475

1825 1475 Jul

1125 775

Stock Price Index (S&P 500) (ratio scale)

425

Fair-Value Price (ratio scale)

1125 775 425

75

75 79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

70

70

60

60

50

50

40

40

30

30

Overvalued

20

20 Jul

10

10 0

0 -10

-10

Undervalued

-20

-20

-30

-30

yardeni.com

-40 79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

-40 02

* Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 17


- Global: United Kingdom (FT 100) -

#21 110

350

STOCK VALUATION MODEL Jul

105

300

100

Industrial Production (1995=100)

250

95 200

Expected Earnings Per Share for FT 100 (pounds)

90

85

150 1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

25

25

23

23

21

21

Fair-Value P/E Jul

19

19

Forward P/E

17

17

15

15

13

13

11

11

9

9

7

7 1988

1989

1990

1991

7900 7100 6300 5500

1992

1993

1994

1995

1996

1997

1998

1999

2000

Stock Price Index (FT 100) (ratio scale)

4700

2001

2002 7900 7100 6300 5500

Jul

4700

Fair-Value (ratio scale)

3900

3900

3100

3100

2300

2300

1500

1500 1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

40

40

30

30

20

20

Overvalued

10

10

0

0

-10

Jul

Undervalued

-10

yardeni.com

-20 1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

* Source: Thomson Financial

Page 18 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

2000

2001

2002

-20


- Global: Japan (TOPIX) -

#22 115

60

STOCK VALUATION MODEL Expected Earnings Per Share for TOPIX (yen)

110

50

Jul

105

Industrial Production (1995=100)

40

100 30

95

90

20 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

150

150

Fair-Value P/E 100

100

Forward P/E Jul

50

50

0

0 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

4500

4500

4000

4000

3500

3500

3000

3000

Stock Price Index (TOPIX)

2500

2500

Fair-Value 2000

2000

1500

1500 Jul

1000

1000

500

500

0

0 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

300

300

Overvalued

200

200

100

100

0

-100

0

Undervalued Jul

yardeni.com 1991

-100 1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

* Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 19


- Global: Germany (DAX) -

#23 120

325

STOCK VALUATION MODEL

300 Jul

110

275 250

Industrial Production (1995=100)

225 200 175

100

150

Expected Earnings Per Share for DAX (Euros)

125 100

90

75 1991

1992

1993

1994

1995

34 32 30 28 26 24 22 20 18 16 14 12 10 8

1996

1997

1998

1999

2000

2001

2002 34 32 30 28 26 24 22 20 18 16 14 12 10 8

Fair-Value P/E Forward P/E Jul

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

11000

11000

9000

9000

7000

7000

5000

Stock Price Index (DAX) (ratio scale)

3000

Fair-Value (ratio scale)

Jul 5000

3000

1000

1000 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

70

70

60

60

50

50

40

40

Overvalued

30

30

20

20 10

10 0

0

Jul

-10

-10

Undervalued

-20

-20

-30

yardeni.com

-40 1991

1992

1993

1994

1995

1996

1997

1998

1999

* Source: Thomson Financial

Page 20 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

2000

2001

2002

-30 -40


- Global: France (CAC 40) -

#24 120 118

275

STOCK VALUATION MODEL Jul

116 114

250 225

112 200

110

Industrial Production (1995=100)

108

175

106 150

104

Expected Earnings Per Share for CAC 40 (Euros)

102 100

125

98

100 1995

1996

1997

1998

1999

2000

2001

29

29

27

27

25

Fair-Value P/E

25

23

Forward P/E

23

21

21 Jul

19

19

17

17

15

15

13

13

11

11 1995

1996

1997

1998

1999

2000

2001

7900 7100 6300 5500

7900 7100 6300 5500 Jul

Stock Price Index (CAC 40) (ratio scale)

4700 3900

4700 3900

Fair-Value (ratio scale)

3100

3100

2300

2300

1500

1500 1995

1996

1997

1998

1999

2000

2001

60

60

40

40

Overvalued

20

20 Jul

0

Undervalued

-20

-20 yardeni.com

-40 1995

1996

1997

0

1998

1999

2000

-40

2001

* Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 21


- Earnings & Output: G6 #25 200

200

GLOBAL G6 EARNINGS INDEX* (Jan 1989=100)

180

180 Jul

The yearly percent change in our Index of Global G6 Earnings is highly correlated with the growth of G7 industrial production.

160

160

140

140

120

120

100

100

yardeni.com

80 1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

80

2002

* Half US and half G5 (Canada, France, Germany, Japan and United Kingdom) 12-month forward consensus expected operating earnings.

#26 30

8

GLOBAL G6 EARNINGS & PRODUCTION (yearly percent change)

25 6 20

15

4

10 2 5

0

0

G6 Earnings Index*

-5

Jul

-2

G7: Industrial Production

-10

yardeni.com

-15 1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

* Half US and half G5 (Canada, France, Germany, Japan and United Kingdom) 12-month forward consensus expected operating earnings.

Page 22 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

-4


- Earnings & Output: US #27 160

65

S&P 500 EARNINGS & INDUSTRIAL PRODUCTION

60

150 8/10

55

140

130

S&P 500 Forward Earnings*

50

Industrial Production (1992=100)

45

120

40

110

35 30

100 25 90 20 80

15

70

10 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Strong correlation between US industrial production and S&P 500 forward earnings.

* 52-week forward consensus expected operating earnings per share. Monthly through March 1994, weekly after. Source: Thomson Financial

#28 30

30

S&P 500 EARNINGS & PRODUCTION (yearly percent change)

25

25

20

20

15

15

10

10

5

5

0

0 Jun

-5 -10

S&P 500 Forward Consensus Earnings*

-15

Industrial Production

-20

8/10

-5 -10 -15

yardeni.com

-20

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

* 52-week forward consensus expected earnings. Monthly through March 1994, weekly after. Source: Thomson Financial First Call

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 23


- Earnings & Output: US #29 86

25

S&P 500 EARNINGS & CAPACITY UTILIZATION

85

Total Capacity Utililzation (percent)

20

84

Growth in S&P 500 forward earnings highly correlated with US capacity utilization rate. Profits tend to increase (decrease) whenever utilization rate is above (below) 79%.

83

15

82 10 81 80

5

79 0 78 77

Jun

-5

S&P 500 Forward Earnings* (yearly percent change)

76

-10

8/10

75 74

-15 86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

* 12-month forward consensus expected operating earnings per share. Monthly through March 1994, weekly after. Source: Thomson Financial.

#30 16 14

2-to-1 is the unusual ratio between growth in S&P 500 forward earnings and growth in G7 production.

32

S&P 500 EARNINGS & G7 INDUSTRIAL PRODUCTION (yearly percent change)

28

12

24

10

20

8

16

6

12

4

8

2

4

0

0 Apr

-2 -4

-4 -8

S&P 500 Forward Earnings*

8/10

-6

-12

G7 Industrial Production -8

-16 yardeni.com

-10

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02

* 12-month forward consensus expected operating earnings per share. Monthly through March 1994, weekly after. Source: Thomson Financial

Page 24 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

-20


- Earnings & Output: Europe #31 50

50

GERMANY: EARNINGS & ORDERS (yearly percent change)

40

40

30

30

20

20

10

10

0

0

Jun Jul

-10

-10

-20

-20

Forward Earnings* Total Manufacturing Orders

-30

-30 yardeni.com

-40 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

-40

2002

* 12-month forward consensus expected operating earnings per share for DAX. Source: Thomson Financial

#32 50

50

GERMANY: EARNINGS & IFO INDEX (yearly percent change)

40

40

30

30

20

20

10

10

0

0

German corporate profits highly correlated with factory orders and business confidence.

Jul -10

-10

Jun

-20

-20

Forward Earnings* IFO Business Climate Index

-30

-30 yardeni.com

-40 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

-40

2002

* 12-month forward consensus expected earnings per share for DAX. Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 25


- Earnings & Output: Europe #33 120

275

FRANCE: EARNINGS & PRODUCTION

118 116

250

Jul

114

Forward Earnings*

112

225

Industrial Production (1995=100)

110 108

200

106 104

175

102 100

150

98 96

125

94 yardeni.com

92 1991

Industrial production is key variable driving profits in France and UK.

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

100

2002

* 12-month forward consensus expected earnings per share for CAC 40. Source: Thomson Financial

#34 110

340

UNITED KINGDOM: EARNINGS & PRODUCTION

108 320 Jul

106

300

104 102

280

100 260 98

Forward Earnings*

240

96

Industrial Production (1995=100)

94

220

92 200 90 yardeni.com

88 1991

1992

1993

1994

1995

1996

1997

1998

1999

* 12-month forward consensus expected earnings per share for FT 100. Source: Thomson Financial

Page 26 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

2000

2001

2002

180


- Earnings & Output: Japan #35 115

60

JAPAN: EARNINGS & PRODUCTION

Forward Earnings*

110

Industrial Production (1995=100)

50

Jul

105 40 100

30 95

yardeni.com

90 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

20

2002

* 12-month forward consensus expected operating earnings per share for TOPIX. Source: Thomson Financial

#36 100

60

JAPAN: EARNINGS & TANKAN BUSINESS CONDITIONS

Japan is falling into recession again. Weak yen boosts exportersâ&#x20AC;&#x2122; earnings. But profits are likely to weaken along with economy.

Forward Earnings*

75

Tankan Business Conditions: Major Manufacturers (diffusion index)

50

50

Jul

25

40

0 30

Q2 -25

yardeni.com

-50 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

20

2002

* 12-month forward consensus expected earnings per share for TOPIX. Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 27


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2001USA00000


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