The Fed, Rates, and Value
Dr. Craig Callahan, ICON Advisers – Founder & President
February 2, 2022
At ICON we calculate intrinsic value by using our proprietary valuation model to assign a value-to-price (V/P) ratio to individual companies. We take average earnings per share (EPS), future earnings growth estimates, beta, and bond yield. Then, using a bottom approach to the market, we aggregate those V/Ps to get individual V/P ratios for industries, sectors, and ultimately the overall market.
As we go through time, we bring new earnings for a company into our valuation equation and we drop off old earnings. Given the big surge in earnings happening in 2021 and 2022, it is possible that earnings will increase our current market V/P of 1.12 over the coming years. Offsetting that, however, is the increase in the 10-year Treasury yield. For our discount rate we build off the 10-year Treasury and add the credit spread for each company’s bond rating.
So there is a race going on. New earnings will boost value. Rising 10-year yield reduces value.
In the Fall of 1993 we had a V/P of 1.22, but the S&P 500 went about nowhere over the next year. The bond yield rose about 33% over that period and ate up or absorbed the boost in value. Currently, for a rise in the Treasury yield to offset our V/P of 1.12 and the expected .15 point earnings boost to V/P, I estimate the yield on the 10-year Treasury would have to increase to 2.25%.
The Fed does its open market operations in the short term T-Bill market. Investors are expecting the yield on T-Bills to increase to 1.00% over 2022. Long term yields like the 10-year Treasury are determined by inflation expectations. Sometimes the two (short and long) can go in different directions. If investors think the Fed actions will not reduce inflation and that inflation will persist, then the yield on the 10-year should keep rising. If, however, investors think inflation will come down, the yield on the 10-year might stay flat or come down.
We don’t see the recent jolt in inflation as sustainable and as as result we expect investor fears to gradually calm down over the next year. In the meantime, ICON will continue to focus on value and filter out the headline-grabbing noise around inflation.
For more information on ICON’s proprietary value system and to learn more about Cr. Callahan’s investment process you can read his book, titled “Unloved Bull Markets: Getting Rich the Easy Way by Riding Bull Markets.”
The data quoted represents past performance, which is no guarantee of future results. Investing in securities involves inherent risks, including the risk that you can lose the value of your investment. There is no assurance that the investment process will consistently lead to successful results. Index performance shown above is not representative of any ICON Funds product or service.
Opinions and forecasts regarding industries, companies and/or themes and portfolio composition and holdings are all subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security, industry or sector.
Investing in securities involves risks. There is no assurance that the investment process will consistently lead to successful results.
ICON’s value-based investing model is an analytical, quantitative approach to investing that employs various factors, including projected earnings growth estimates and bond yields, in an effort to determine whether securities are over- or underpriced relative to ICON’s estimates of their intrinsic value. ICON’s value approach involves forward-looking statements and assumptions based on judgments and projections that are neither predictive nor guarantees of future results. Value readings are contingent on several variables including, without limitation, earnings, growth estimates, interest rates and overall market conditions. Although valuation readings serve as guidelines for our investment decisions, we retain the discretion to buy and sell securities that fall beyond these guidelines as needed. Value investing involves risks and uncertainties and does not guarantee better performance or lower costs than other investment methodologies.
ICON’s value-to-price ratio is a ratio of the intrinsic value, as calculated using ICON’s proprietary valuation methodology, of a broad range of domestic and international securities within ICON’s system as compared to the current market price of those securities. According to our methodology, a V/P reading of 1.00 indicates stocks are priced at intrinsic value. We believe stocks with a V/P reading below 1.00 are overvalued while stocks with a V/P reading above 1.00 are undervalued. For example, we interpret a V/P reading of 1.15 to mean that for every $1.00 of market value, there is $1.15 of intrinsic value which has not yet been realized in the market price.
The unmanaged Standard & Poor’s (S&P) 500 Index is a market value-weighted index of large-cap common stocks considered representative of the broad market. Total return for the unmanaged index includes the reinvestment of dividends and capital gain distributions but do not reflect deductions for commissions, management fees, and expenses. Individuals cannot invest directly in an index.
The 10-year yield is the benchmark 10-year yield to maturity reflected by the current issue 10 year U.S. Treasury note.
A Treasury bill (T-Bill) is a short-term debt obligation backed by the Treasury Dept. of the U.S. government with a maturity of less than one year.
Please visit ICON online at www.ICONAdvisers.com or call 1-800-828-4881 for the most recent copy of ICON’s Form ADV, Part 2.
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ICON Advisers, Inc. is the sub-adviser to the ICON Funds. RFS Partners is the distributor of the ICON Funds.