Research Deutsche Banc Alex.

Brown
Equity

Global
Strategy

August 13, 2001 Asset Valuation & Allocation Models

Global

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 stocks-
versus-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
2
“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

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 ten-
year 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 -[FEY-
CBY]/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
Page 6 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models

#1
75 75
70 ED YARDENI’S ASSET ALLOCATION MODEL: STOCKS/BONDS 70
(for large equity funds)
65 65
60 Stocks overvalued when greater than zero 60
55 Stocks undervalued when less than zero 55
50 50
45 45

- Asset Allocation -
40 40
35 35
30 30
25 60/40 25
20 20
15 70/30 15
10 10
8/10
5 5
80/20
0 0
-5 80/20 -5
-10 -10
-15
85/15 -15
-20 90/10 -20
-25 -25
-30 -30
-35 -35
yardeni.com
-40 -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

* 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
 - Valuation Model -
#2
1725 1725
1575 FED’S STOCK VALUATION MODEL 1575
1425 (ratio scale) 1425
1275 1275
8/10
1125 1125
975 975
825 S&P 500 Price Index 825

675 675
Fair-Value Price*
525 525

375 375

225 225

According to the
Fed model, when
stock prices are
yardeni.com
75 75 overpriced, returns
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
from stocks are
* 12-month forward consensus expected S&P 500 operating earnings per share divided by likely to be subpar
10-year US Treasury bond yield. Monthly through March 1994, weekly after.
Source: Thomson Financial over the next 12-24
months.
#3
Better-than-average
70 70 returns tend to
FED’S STOCK VALUATION MODEL* come from
(percent)
60 60 underpriced
markets.
50 50

40 40

30 30

20 20
Overvalued

10 8/10 10

0 0

-10 -10

-20
Undervalued -20

-30 -30

yardeni.com
-40 -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 18
S&P 500 EARNINGS YIELD & BOND YIELD
17 17
16 16
15 15
This chart appeared Forward Earnings Yield*
14 14
in the Fed’s July 10-Year US Treasury
1997 Monetary 13 Bond Yield 13
Policy Report to the 12 12
Congress. It shows 11 11
a very close 10 10
correlation between
9 9
the earnings yield of
the stock market 8 8
and the bond yield. 7 7
Another, more 6 6
familiar way to look 5 5
at it follows. 8/10
4 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
26 26
25
P/E & BOND YIELD 25
24 24
23 23
22 22
The S&P 500 P/E 21
Ratio of S&P 500 Price to Expected Earnings* 8/10
21
(using expected 20 Fair-Value P/E=Reciprocal of 20
earnings) is highly 19 10-Year US Treasury Bond Yield 19
correlated with 18 18
reciprocal of the 17 17
bond yield. 16 16
15 15
14 14
13 13
12 12
11 Actual Fair 11
Jun 29 21.7 18.9
10 Jul 6 21.8 18.5 10
9 Jul 13 21.4 18.8 9
Jul 20 21.7 19.4
8 Jul 27 21.5 19.4 8
7 Aug 3 21.9 19.5 7
Aug 10 21.5 19.7
6 6
yardeni.com
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 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 75
S&P 500 EARNINGS PER SHARE
(analysts’ average forecasts)

70 Consensus Forecast 70
for 2001 Consensus Forecast
for 2002 Expected forward
earnings is a
65 65 time-weighted
average of current
Forward Earnings*
and the coming
60 60
years’ consensus
forecasts.

55 Consensus Forecast 8/10 55

for 2000

50 50

yardeni.com
45 45
I II III IV I II III
2000 2001
* 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 Q1 8/9 55
Forward Earnings* Bottom-up 52-week
(pushed 52-weeks ahead) forward expected
50 50
Operating Earnings earnings tends to be
(4-quarter sum)
45 45 a good predicator of
actual earnings, with
40 40
a few significant
35 35 misses.

30 30

25 25

20 20

15 15

yardeni.com
10 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 75
S&P 500 CONSENSUS OPERATING EARNINGS PER SHARE
(analysts’ bottom-up forecasts)
70 02 70
01
Consensus Forecasts
__________________
65 65
12-month forward
60 Annual estimates 00 60
99
Actual 4Q sum
55 Jul 55
98

50 50
97

45 96 45

40 40
95
35 94 35
91 92 93

30 30

25 25

yardeni.com
20 20
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Analysts always
start out too Source: yardeni.com. Do not reprint without permission.
optimistic about the
prospects for
earnings. #9
35 35
S&P 500 CONSENSUS OPERATING EARNINGS PER SHARE
(analysts’ bottom-up forecasts, ratio scale) 90
30 30
Consenus Forecasts
_________________
89
12-month forward
Annual estimates 88
25 25
Actual 4Q sum 85 87
86
82 83
20
84 20

81

80
15 15

yardeni.com
10 10
1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

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

Page 10 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
 - Earnings -
#10
25 25
S&P 500 EARNINGS PER SHARE

20 8/10 20

The data on
15 15
consensus expected
Consensus Growth earnings can be
10 Forecasts*
_______________ 10 used to derive
2001/2000 consensus earnings
5 2002/2001 5
growth forecasts.

0 0

-5 -5

8/10
-10 -10

yardeni.com
-15 -15
I II III IV I II III
2000 2001
* Based on consensus expected S&P 500 operating earnings for years shown.
Source: Thomson Financial

#11
35 35
S&P 500 OPERATING EARNINGS PER SHARE*
(yearly percent change)
30 30
Actual
25 25
Consensus Forecast (Proforma)* Earnings growth is
20 20 highly cyclical.

15 15

10 10

5 5

0 Q4 0

-5 -5

-10 -10

-15 -15

yardeni.com
-20 -20
1994 1995 1996 1997 1998 1999 2000 2001 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 1600

Model builds on the .25

1400 1400
simple one by S&P 500 Index
adding variables for Fair Value* Jul
1200 .20 1200
long-term expected 5-year earnings
earnings growth and 1000 growth weight
_____________
1000
risk. .25
.10
800 .20 800
.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 30
LONG-TERM CONSENSUS EARNINGS GROWTH*
(annual rate, percent)

Long-term earnings S&P 500

25 25
growth expectations S&P 500
rose sharply during Technology
1990s. Now they
Ex Technology
are coming back
down to the Planet 20 20
Earth.

Jul
15 15

yardeni.com
10 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
 - New Improved Model -
#14
40 40
MARKET’S WEIGHT FOR 5-YEAR CONSENSUS EXPECTED EARNINGS GROWTH*
(percent)
35 35
Weight market gives to long-term earnings growth
________________________________________
30 value > 13% = more than average weight 30 Investors have on
value < 13% = less than average weight
average over time
25 25 subtracted 13% of
their long-term
20 Jul 20
earnings growth
expectations from
the corporate bond
15 15
Average = 13% yield to determine
earnings yield.
10 10

5 5

0 0

yardeni.com
-5 -5
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* Moody’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 1.5
P/E ratio for S&P 500
divided by 5-year consensus
Jul
Historically, S&P
1.4 expected earnings growth* 1.4
500 sold at P/E of
1.2 times long-term
1.3 1.3 expected earnings
growth, on average,
1.2
Average = 1.2
1.2
with quite a bit of
volatility.
1.1 1.1

1.0 1.0

.9 .9

yardeni.com
.8 .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 7

yardeni.com
Corporate bond 6 6
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
yield variable in
New Improved * Source: Moody’s Investors Service
Model captures risk
that earnings will be
weaker than #17
expected. 300 300
CORPORATE SPREAD
(basis points)

250 Moody’s A-Rated corporate bond yield minus 250

8/10
10-Year US Treasury bond yield

200 200

Average = 156
150 150

100 100

yardeni.com
50 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
 - Global: Stock Valuation -
#18
80 80
UNITED STATES
60 60
40 Overvalued 40
20 20
Jul
0 0
-20 -20
Undervalued
-40 -40
1995 1996 1997 1998 1999 2000 2001
30 30
UNITED KINGDOM
20 Overvalued 20

10 10

0 0

-10 Undervalued Jul -10

-20 -20
1995 1996 1997 1998 1999 2000 2001
200 200
JAPAN
150 150
100 100
Overvalued
50 50
0 0
-50 -50
Undervalued Jul
-100 -100
1995 1996 1997 1998 1999 2000 2001
80 80
GERMANY
60 60
40 Overvalued 40
20 20
0 Jul 0
-20 Undervalued -20
-40 -40
1995 1996 1997 1998 1999 2000 2001
60 60
FRANCE
40 40

20 Overvalued 20

0 Jul 0

-20 Undervalued -20

-40 -40
1995 1996 1997 1998 1999 2000 2001
50 50
CANADA
30
Overvalued 30

10 10
Jul
-10 -10
Undervalued
yardeni.com
-30 -30
1995 1996 1997 1998 1999 2000 2001

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 15
 #19
- Global: Expected Earnings* -
65 325
UNITED STATES (S&P 500) GERMANY (DAX)
300
60
Jul
275
55 Jul
250
50
225
Expected EPS* Expected EPS
45 (dollars) (euros) 200

175
40
150
35
125
30
100

25 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

550 280
CANADA (TSE 300) FRANCE (CAC 40)
525
260
500 Jul
475 240
Jul Expected EPS
450
(euros) 220
425
Expected EPS
(Canadian dollars)
400 200

375 180
350
160
325
300 140
275
120
250
225 100
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

360 70
UNITED KINGDOM (FT 100) JAPAN (TOPIX)
340

60
320
Jul
300 Expected EPS Expected EPS
(pounds) (yen)
Jul 50
280

260
40
240

220 30

200
yardeni.com
180 20
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) -
160 70
STOCK VALUATION MODEL
150
60
140 Jul
130 50
Industrial Production
120 (1987=100)
40
110

100 30

90 Expected Earnings Per Share* 20

80 For S&P 500 (dollars)

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
Forward P/E Jul

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 1825
1475 1475
1125 Jul 1125
Stock Price Index (S&P 500)
775 (ratio scale) 775

Fair-Value Price
425 (ratio scale) 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
-20 Undervalued -20
-30 -30
yardeni.com
-40 -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

* Source: Thomson Financial

Deutsche Banc Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 17
 #21
- Global: United Kingdom (FT 100) -
110 350
STOCK VALUATION MODEL

105 Jul
300

100
Industrial Production
(1995=100) 250
95

200
90 Expected Earnings Per Share
for FT 100 (pounds)

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
19 Jul 19
Forward P/E
17 17

15 15

13 13

11 11

9 9

7 7
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
7900 7900
7100 7100
6300 6300
5500 Stock Price Index (FT 100) Jul 5500
(ratio scale)
4700 4700

3900 Fair-Value 3900

(ratio scale)
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 Undervalued Jul -10

yardeni.com
-20 -20
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* Source: Thomson Financial

Page 18 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
 #22
- Global: Japan (TOPIX) -
115 60
STOCK VALUATION MODEL

110 Expected Earnings Per Share

for TOPIX (yen) Jul 50

105
Industrial Production 40
(1995=100)
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 0
Undervalued
Jul
yardeni.com
-100 -100
1991 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
 #23
- Global: Germany (DAX) -
120 325
STOCK VALUATION MODEL
300
Jul
275
250
110 Industrial Production
(1995=100) 225
200
175
100
150
Expected Earnings Per Share 125
for DAX (Euros)
100
90 75
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
34 34
32 32
30 30
28 Fair-Value P/E 28
26 Forward P/E 26
24 24
22 22
20 Jul 20
18 18
16 16
14 14
12 12
10 10
8 8
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
11000 11000
9000 9000
7000 7000
Jul
5000 Stock Price Index (DAX) 5000
(ratio scale)

Fair-Value
3000 (ratio scale) 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 Jul 0
-10 Undervalued -10
-20 -20
-30 -30
yardeni.com
-40 -40
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* Source: Thomson Financial

Page 20 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models
 #24
- Global: France (CAC 40) -
120 275
STOCK VALUATION MODEL
118
Jul 250
116
114 225
112
110 200
Industrial Production
108 (1995=100) 175
106
104 150
102 Expected Earnings Per Share
for CAC 40 (Euros) 125
100
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

19 Jul 19

17 17

15 15

13 13

11 11
1995 1996 1997 1998 1999 2000 2001
7900 7900
7100 7100
6300 6300
5500 5500
Stock Price Index (CAC 40) Jul
4700 4700
(ratio scale)
3900 3900
Fair-Value
3100 (ratio scale) 3100

2300 2300

1500 1500
1995 1996 1997 1998 1999 2000 2001
60 60

40 40

20 Overvalued 20

Jul
0 0

Undervalued
-20 -20

yardeni.com
-40 -40
1995 1996 1997 1998 1999 2000 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

160 160

140 140

120 120

100 100

The yearly percent yardeni.com

80 80
change in our Index 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
of Global G6 * Half US and half G5 (Canada, France, Germany, Japan and United Kingdom) 12-month
Earnings is highly forward consensus expected operating earnings.
correlated with the
growth of G7
industrial #26
30 8
production. GLOBAL G6 EARNINGS & PRODUCTION
(yearly percent change)
25
6
20

15 4

10
2
5

0 0

-5 G6 Earnings Index*
Jul
-2
-10 G7: Industrial Production

yardeni.com
-15 -4
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
 - Earnings & Output: US -
#27
160 65
S&P 500 EARNINGS & INDUSTRIAL PRODUCTION
60
150
8/10 55
140
S&P 500 Forward Earnings* 50
130
Industrial Production 45
(1992=100)
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
* 52-week forward consensus expected operating earnings per share. Monthly through between US
March 1994, weekly after.
Source: Thomson Financial industrial production
and S&P 500
#28
forward earnings.
30 30
S&P 500 EARNINGS & PRODUCTION
(yearly percent change)
25 25

20 20

15 15

10 10

5 5

0 0

Jun
-5 -5

-10 S&P 500 Forward Consensus Earnings* -10

8/10

-15 Industrial Production -15

yardeni.com
-20 -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
83 15
forward earnings
highly correlated 82
with US capacity 10
utilization rate. 81
Profits tend to 80 5
increase (decrease)
whenever utilization 79
rate is above 0
78
(below) 79%.
77 Jun -5

76 S&P 500 Forward Earnings*

(yearly percent change) -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 32
S&P 500 EARNINGS & G7 INDUSTRIAL PRODUCTION
14 (yearly percent change) 28

12 24
2-to-1 is the unusual 10 20
ratio between
growth in S&P 500 8 16

forward earnings 6 12
and growth in G7
4 8
production.
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 -20
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
 - 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 Forward Earnings* -20

Total Manufacturing Orders

-30 -30

yardeni.com
-40 -40
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 German corporate
* 12-month forward consensus expected operating earnings per share for DAX.
profits highly
Source: Thomson Financial correlated with
factory orders and
business
#32 confidence.
50 50
GERMANY: EARNINGS & IFO INDEX
(yearly percent change)
40 40

30 30

20 20

10 10

0 0
Jul
-10 Jun -10

-20 Forward Earnings* -20

IFO Business Climate Index

-30 -30

yardeni.com
-40 -40
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 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 Jul 250

114
Forward Earnings*
112 225

110 Industrial Production

(1995=100)
108 200

106

104 175

102

100 150

98

96 125

94
yardeni.com
92 100
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Industrial production * 12-month forward consensus expected earnings per share for CAC 40.
is key variable Source: Thomson Financial
driving profits in
France and UK.
#34
110 340
UNITED KINGDOM: EARNINGS & PRODUCTION
108
320
106 Jul

300
104

102 280

100
260
98
Forward Earnings*
96 240
Industrial Production
94 (1995=100)
220

92
200
90

yardeni.com
88 180
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

* 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
 - Earnings & Output: Japan -
#35
115 60
JAPAN: EARNINGS & PRODUCTION

Forward Earnings*
110
50
Industrial Production Jul
(1995=100)

105

40

100

30
95

yardeni.com
90 20 Japan is falling into
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
recession again.
* 12-month forward consensus expected operating earnings per share for TOPIX. Weak yen boosts
Source: Thomson Financial exporters’ earnings.
But profits are likely
#36
to weaken along
100 60 with economy.
JAPAN: EARNINGS & TANKAN BUSINESS CONDITIONS

75 Forward Earnings*

Tankan Business Conditions: 50

Major Manufacturers Jul
50
(diffusion index)

25 40

30
Q2
-25

yardeni.com
-50 20
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 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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