Jun 20, 2012 | Post by: Roman Chuyan, CFA Comments Off on Expected Return for Equities Improves Slightly, Still Negative

Expected Return for Equities Improves Slightly, Still Negative

As of May 31, 2012

The PAR Model ™ changed to a less negative position in May:

S&P 500 6-m expected return:  4.4%
Recommended allocation:               Underweight
Prior month                                        -6.8%
Change                                              2.3%

The PAR Model ™ had predicted a 6-month market drop, at -5.2% in March, confirmed by -6.8% forecast in April, and we recommended an Underweight to equities starting from the March report. The S&P 500 dropped by about 6% in May. As of May 31st, the model changed its stance to a smaller, but still negative, expected return of -4.4%. Based on this result, we recommend to continue being underweight public equities relative to your benchmark.

Deals

Every major market top has its prominent deal that fails as the market crashes. In 2000, it was the merger of AOL and Time Warner. The price tag of $164 billion reflected the excitement about the internet that prevailed at the time. As the dot-com bubble burst, the value of AOL’s internet assets plunged, and the expected merger synergies never materialized. “AOL“ was dropped from the company name in 2003.

The credit bubble and its component markets had their own enterprises that were revered by many before failing spectacularly. The subprime mortgage industry had Countrywide Financial. The leveraged loan market witnessed the LBO of Tribune in 2007, which filed for bankruptcy in the following year.

The highly-anticipated IPO on May 17th priced Facebook at $104 billion, making it the largest newly-public company in history. But as of June 1st, its price already fell 27% from the offering price. Was the price inflated at about 70 times expected current year earnings? Perhaps, with the demand being driven more by fascination about social media then by fundamentals. But more important is the fact that the market had already turned, and just could not absorb the $16 billion being raised. Will Facebook go in history as the failed deal that marked the top of the social-media bubble? The historical parallels are certainly compelling.

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