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Equity Market Update S&P 500 Index

To aid investment committees in their effort to maneuver through buy, hold and sell decisions within equities, we have provided a snapshot into a the large cap segment of the market.

The first chart lists the current P/E for the index and it’s sectors based on 2013 EPS estimates. S&P lists the PEG ratios for each. The PEG ratio divides the P/E by projected growth rates. A level of 1 implies a fairly valued market, a level above that an expensive market and below 1 a cheap market.

Just based on this metric, the overall market is rich, the IT sector is cheap while Telecomm and Utilities are expensive.

Source-S&P Website through 1/17/13


S&P 500

S&P 500 5YR

S&P 500


2013 EST











Consumer Discretionary




Consumer Staples












Health Care








Information Technology








Telecommunication Services








This information could be used along with additional metrics to determine areas within the market that may warrant closer attention for sale or purchase.

PEG ratios have severe limitations and should be used to possibly begin a search and  should be used as only one of many metrics to determine value. Each industry or sector should be evaluated for the appropriateness of the PEG ratio as a metric.

Below is a small table that displays the EPS estimates by S&P and below is a short explanation for each of the estimate methodologies. We enjoy taking a simple average for scenarios with various P/E ratios to help define a potential range for the S&P 500.

We then show a couple hypothetical scenarios although there are more assumptions and more scenarios.








(ests are

(ests are

(ests are

bottom up)

top down)

top down)




Operating earnings: Income from product (goods and services),
As Reported earnings: Income from continuing operations, also known GAAP (Generally Accepted Accounting Principles)
Bottom up estimate: Capital IQ consensus estimate for specific issue, building from the bottom up to the index level estimate
Top down estimate: S&P estimate (Economics Department) incorporates models (economic, financial, policy), does not comel

$106.80 is the average of the three estimates for the S&P 500 and at today’s price of $1494 the p/e is 13.98x.

While reasonable, if margins or sales contract, EPS will also come down. If estimates are high by 10%, the EPS comes in at $96.12. This leaves the index at 1345 if the same P/E is applied.  This would be a 10% correction.

Assume the same growth of EPS comes in and we apply a 15x EPS. The index would climb to 1600 or 7% higher.

The basic range then is 10% downside with 7% upside with these simplistic assumptions.

Given this, we recommend an examination of your portfolio beta to determine if your risk is higher or lower than the overall market as defined by the S&P 500. If you are more concerned about the downside, then sell some higher beta names for lower ones while maintaining equity exposure within pre-defined ranges.

Lastly, it is good to look at revenue and margins.

Here are two additional growth rates with respect to sales and margins for the S&P 500.

S&P 500 Sales/share rose from $272.64 to $282.38/share for a 3.57% increase YoY through Dec 31, 2012

Operating Margins rose from 8.7% to 8.92% through the same period.

While positive overall, it makes sense to dissect your holdings to determine if your funds overall are growing Sales, Margins and EPS faster or slower than the S&P500. Talk to your mutual fund managers to determine if they are worth holding based on comparable metrics.

While this short piece simplifies S&P 500 index level approximation, it can serve as a guide and one piece of input into your firm’s equity outlook.


Fed action and investments

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Zenith talking points for investment committees

QE3 and asset class performance and assessment-The FED and the ECB have created an asset class tailwind in two distinctly different areas. The FED has especially added to this as they announced the purchase of $40 bill/month of agency mortgage backed debt for a long time.

1. Mortgage Backed Debt-

  • Agency Debt-Fannie and Freddie debt will be purchased but the yields are a paltry 1.5%-2.25% depending on the issue.
  • Non-Agency RMBS or private label will not be purchased by the Fed as they do not carry an implicit Government guarantee. The yields range from 5%-6% generally.
  • YTD-These securities have performed well and the performance varies by manager selection. Factors include the amount dedicated to non-agency debt, prime or ALT-A and duration management.
  • Talk to your fund management team to assess their positioning and if it continues to fit your firm’s risk objective.
  • If the fund is too heavily weighed in Agency debt, the return may be low going forward in spite of Fed support.
  • If the fund is taking on a lot of Non-Agency credit risk, there could be potential poor performance if conditions deteriorate in the housing market.

2.  Metals and Miners

  • These stocks have generally performed very well since the QE announcement and include basic materials such as copper and precious metals such as gold.
  • The base metals as represented by the futures based ETFs and funds have also performed well as the inflation expectations from the QE announcement have risen substantially.
  • We advise separating the precious metals from the base metals and material producers as they both have different performance drivers.
  • They have both appreciated in large part due to the QE announcement although sustained global demand will determine the sustainability of the rise in base metals while currency debasement could shape the future of gold.
  • Assess the valuation metrics of your metals and miners funds or ETFs to determine if they continue to look attractive given your firm’s risk objectives.


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Gold Update-

MPT Statistics 3yrs prior through 12/31/12 for–   IAU-I-Shares Gold Trust

Standard Deviation 19.29%- Important for allocation %

Against the Morningstar Long Only Commodity Category

Upside capture 83.09

Downside capture 45.50

Alpha 11.48

These are positive statistics and why we believe it is prudent to separate the precious metals component from broad based indexes, both strategically and tactically.


These are four major factors cited recently by the World Gold Council that lend support to the investment case for gold.

  • Inflation risk
  • Medium-term tail-risk from imbalances
  • Currency debasement and uncertainty
  • Low real rates and emerging market real rate differentials

Zenith’s commentary on each factor

1. Inflation risk-While there is much debate on the true dynamics of inflation, there has not been a massive upsurge in traditionally defined inflation (CPI). This is in spite of a massive quantitative easing campaign by the world’s central banks. In part this is due to the continued decline in the velocity of money in the economy. At least in the US, bank lending is still very slow and in Europe the economy is anemic at best.

Also, it is important to note that gold has not always been correlated with inflation over certain periods of time.

2. The massive imbalances across sovereign balance sheets globally is worrisome especially as countries attempt to balance growth and austerity. Also, credit buildup in risk assets is fostered in large part by artificially low interest rates. While temporarily beneficial, most credit imbalances correct themselves and gold may hedge this risk.

3. The “race to the bottom” continues as monetary authorities continue expansionary monetary policy. Japan’s latest attempt to break free of deflationary forces is just one of many examples of forced currency devaluation.

4. Low real interest rates have been a positive factor for gold. While this should continue, a surge in inflation may prompt central banks to tighten earlier than expected possibly increasing real interest rates depending on the degree of tightening.


Gold holdings for sovereigns as of Sept 2012


Country Tons of Gold held in reserves % of foreign reserves held as gold
US 8133 77.7%
Germany 3396 74%
Italy 2451 70.9%
France 2435 73%
China 1054 2%


Statistics are taken from the IMF and presented by the World Gold Council. While updated in September, there may be numbers that are a couple months old.

We feel that China will continue to purchase gold in order to diversify it’s reserves. At 2%, it has a long way to go in order to approach many developed countries percentages  or to even produce a reasonable hedge against its paper assets.


Third quarter 2012 gold demand statistics


Source of Demand % change in demand in Q3 ’12 from Q3 ’11
Jewelry Demand -2%
Technology -6%
Investment -16%
Official Sector -31%

Third quarter demand was up 10% compared to the second quarter but 11% less than the 3rd quarter a year earlier. The %s in the table are weighted and given the underlying weightings represent an average of -11% decline.

This is not as significant as it appears as 2011 was a record year in many respects for gold purchases. Jewelry demand will ebb and flow mainly with the Indian and Chinese economies while investment demand is partly dependent on a large investor block continuing to believe in inflation potential and central bank balance sheet expansion.

 Bear case


  • Dollar strength-Gold and the $ have traditionally been negatively correlated. The flight to safety and out of European denominated assets has given the dollar a strong boost. As attention may turn to our own fiscal issues, the dollar may not continue appreciating. Also, even if it holds at these levels, there could be a case that institutions that are overweight dollars, may seek to diversify into gold.


  • Emerging market weakness continues-Consumers in India and China are unable to consistently buy gold if their economy slows.


  • Deflation-Since gold is perceived as only an inflation hedge by some investors, a global inflation slowdown with deflation could place pressure on this metal.


Bull Case


  • Deflationary concerns in some countries provide room for further fiscal and monetary stimulus. This may lead to a further debasement of currencies through unconventional monetary policy.
  • The underlying structural issues that affect the euro zone remain unresolved, despite advances in the formation of more comprehensive burden-sharing mechanisms. In such an environment of uncertainty and higher market volatility, gold will continue to be an asset that investors use to diversify risk and preserve capital.
  • Negative interest rates persist in many markets with inflation fears elevated.


We recommend that investment committees examine each factor that supports the case for gold. Determine the factors prevalence going forward and the risk to each one. A full examination would include historical and current correlation trends as well as a closer look at each segment of demand.