InvestWELL Financial Inc. - Monthly Monitor

Markets This Week
February 4, 2006 In This Issue: Investment Idea Quiz Market Highlights S&P 500 Chart TSX Chart Behavioral Finance Indicators Answer to the Quiz Investment Idea Q: What is the best measure of equity valuations? A: The price-to-earnings ratio (P/E) is one of the best measure. It works really well if one compares two companies within the same industry and under the same accounting system. The P/E ratio tells us how much investors are willing to pay for the company's future profits. There are times when the share prices get depressed (low P/E) or become too expensive (high P/E). At times, when investors are hoping for company's high growth, the disappointment can quickly bring down the price (the P portion) and adjust the P/E ratio down. For example, let us compare the P/E ratio of Google (symbol GOOG) with Yahoo (symbol YHOO). Currently, Google's P/E = 76 and Yahoo's P/E = 35. In January 2006, Google's P/E was over 100. However, the recent quarterly earnings came below expectations (which were very high) and the share price declined by 19.7% since its all time high (Chart 1). Chart 1. Google's Price and P/E Charts courtesy of BigCharts.com Quiz You are given the following information. The company's price per share is $10, book value per share is $5 and earnings per share are $1. The press also reports that the company's president recently separated from his wife and now lives with his mother in a dark basement apartment. What is the P/E ratio? A) 10 B) 5 C) 2 D) 1 Answer to the Quiz at the bottom of the document Market Highlights Jan 28 - Feb 4 The equity markets fell heavily since Tuesday (Charts 2 - 5). The media believes the fall was related to the political uncertainty and disappointing quarterly earnings. Here is a quote from our previous weekly newsletter "A number of indicators show that equities will likely decline in February". We believe that given the deterioration in technical fundamentals and general over-optimism, there is a high probability that the equity markets will decline for some time following the high reached in January 2006. The US FED raised interest rates to 4.5%. The Fed's chairman Alan Greespan officially retired and was replaced by Ben S. Bernanke. The markets will try to assess the effectiveness of the new chairman. The US productivity (i.e. production growth minus hours worked) fell by -0.6% last quarter. Apart from the short-term volatility, the long-run changes in productivity are the most important variable in defining economic wealth of a country. The US unemployment fell to its 5-year low of 4.7%. However, the raw unemployment data does not give an accurate picture of the weakness in the job market. The better measure known as nonfarm payrolls or new jobs created continues to disappoint. Exxon posted record profits for any US company -- $10.71 billion for the fourth quarter. We are very happy that Exxon is finally making "some" money. Worth Watching The Canadian dollar hit 0.8741, its 14-year high on expectations of higher prices for oil, natural gas and base metals. It is quite likely that the Canadian dollar will continue to climb not so much due to the prices of resources but because of the high chance of the US dollar weakness. According to the Re/Max survey, one in six respondants plan to buy real estate as an investment in the next two years. As the real estate market cools down, we expect to see more "surveys" done by Re/Max. S&P 500 Chart 10 Years Last 10 Days Charts courtesy of StockCharts.com TSX Chart 10 Years Last 10 Days Charts courtesy of StockCharts.com Behavioral Finance Indicators (see explanation) According to our contrary indicators, there is a high probability that equities are going through a correction phase (in other words going down). The equity markets appeared to form a top in the middle of January 2006 (Chart 6 - 9) and as we know economy and stock markets are very hard to predict but they are cyclical. Please have a look the the provided indicators and compare the markets in January and the beginning of last August. Chart 6. S&P 500: 1 Year Chart courtesy of StockCharts.com Chart 7. New York: Advancing / Declining Ratio Chart courtesy of StockCharts.com Chart 8. AAII Chart courtesy of DecisionPoint.com Chart 9. Put / Call Ratio Chart courtesy of StockCharts.com Answer to the Quiz A is correct. We divide 10 by 1. The book value and the information about the current residence of the company's president are irrelevant for the calculation.
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