Asset Valuation Allocation Models

(1)

Global

Equity

Resear

c

h

Deutsche Banc Alex. Brown

Deutsche Bank

Global

Strategy

August 13, 2001

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

(2)

-

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)

2)

FVP = E/TBY

Ex

cerpt 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.

(4)

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

(5)

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

(6)

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02

-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35

40

45

50

55

60

65

70

75 -40

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35

40

45

50

55

60

65

70

75 #1

ED YARDENI’S ASSET ALLOCATION MODEL: STOCKS/BONDS

(for large equity funds)

Stocks overvalued when greater than zero

Stocks undervalued when less than zero

60/40

70/30

80/20

85/15

90/10

8/10

* 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.

yardeni.com

Asset Allocation

-Page 6 /

August 13, 2001

/ Deutsche Banc Alex. Brown

(7)

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 75 225 375 525 675 825 975 1125 1275 1425 1575 1725

75 225 375 525 675 825 975 1125 1275 1425 1575 1725

8/10

FED’S STOCK VALUATION MODEL (ratio scale)

Fair-Value Price* S&P 500 Price Index

* 12-month forward consensus expected S&P 500 operating earnings per share divided by 10-year US Treasury bond yield. Monthly through March 1994, weekly after.

Source: Thomson Financial

yardeni.com

#2

According to the

Fed model, when

stock prices are

overpriced, returns

from stocks are

likely to be subpar

over the next 12-24

months.

Better-than-average

returns tend to

come from

underpriced

markets.

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 -40 -30 -20 -10 0 10 20 30 40 50 60 70

-40 -30 -20 -10 0 10 20 30 40 50 60 70

8/10

FED’S STOCK VALUATION MODEL* (percent)

Overvalued

Undervalued

* 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.

yardeni.com

#3

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-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 2

S&P 500 EARNINGS YIELD & BOND YIELD

10-Year US Treasury Bond Yield

Forward Earnings Yield*

* 12-month forward consensus expected S&P 500 operating earnings per share divided by S&P 500 Index. Monthly through March 1994, weekly after.

yardeni.com

#4

This chart appeared

in the Fed’s July

1997 Monetary

Policy Report to the

Congress. It shows

a very close

correlation between

the earnings yield of

the stock market

and the bond yield.

Another, more

familiar way to look

at it follows.

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 5

P/E & BOND YIELD

Fair-Value P/E=Reciprocal of 10-Year US Treasury Bond Yield

Ratio of S&P 500 Price to Expected Earnings*

* 12-month forward consensus expected S&P 500 operating earnings per share. Monthly through March 1994, weekly after.

yardeni.com

#5

The S&P 500 P/E

(using expected

earnings) is highly

correlated with

reciprocal of the

bond yield.

(9)

-I II III IV I II III

2000 2001

45 50 55 60 65 70 75

8/10

S&P 500 EARNINGS PER SHARE (analysts’ average forecasts)

Consensus Forecast for 2002

Forward Earnings*

* 52-week forward consensus expected S&P 500 operating earnings per share. Source: Thomson Financial

yardeni.com

#6

Expected forward

earnings is a

time-weighted

average of current

and the coming

years’ consensus

forecasts.

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 10 15 20 25 30 35 40 45 50 55 60 65

10 15 20 25 30 35 40 45 50 55 60 65

Q1 8/9

S&P 500 EARNINGS PER SHARE: ACTUAL & EXPECTED

S&P 500 Earnings Per Share ________________________

Operating Earnings (4-quarter sum) Forward Earnings* (pushed 52-weeks ahead)

* 52-week forward consensus expected S&P 500 operating earnings per share. Monthly through March 1994, weekly after.

yardeni.com

#7

Bottom-up 52-week

forward expected

earnings tends to be

a good predicator of

actual earnings, with

a few significant

misses.

(10)

-1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 20 25 30 35 40 45 50 55 60 65 70 75

20 25 30 35 40 45 50 55 60 65 70 75

Jul

S&P 500 CONSENSUS OPERATING EARNINGS PER SHARE (analysts’ bottom-up forecasts)

Consensus Forecasts __________________

Annual estimates 12-month forward

Actual 4Q sum

91 ₉₂ 93 94

95 96

97 98

99 00

01 02

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

yardeni.com

#8

Analysts always

start out too

optimistic about the

prospects for

earnings.

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 10 15 20 25 30 35

10 15 20 25 30 35

S&P 500 CONSENSUS OPERATING EARNINGS PER SHARE (analysts’ bottom-up forecasts, ratio scale)

Consenus Forecasts _________________

Annual estimates 12-month forward

Actual 4Q sum

80 81

82 83

84

85 ₈₆ 87

88 89

90

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

yardeni.com

#9

(11)

-I II III IV I II III

2000 2001

-15 -10 -5 0 5 10 15 20 25

8/10 8/10

S&P 500 EARNINGS PER SHARE

Consensus Growth Forecasts* _______________

2001/2000

2002/2001

* Based on consensus expected S&P 500 operating earnings for years shown. Source: Thomson Financial

yardeni.com

#10

The data on

consensus expected

earnings can be

used to derive

consensus earnings

growth forecasts.

1994 1995 1996 1997 1998 1999 2000 2001 2002 -20 -15 -10 -5 0 5 10 15 20 25 30 35

-20 -15 -10 -5 0 5 10 15 20 25 30 35

Q4

S&P 500 OPERATING EARNINGS PER SHARE* (yearly percent change)

Consensus Forecast (Proforma)* Actual

* S&P 500 composition is constantly changing. Actual data are not adjusted for these changes. Proforma forecasts are same-company comparisions. Source: Thomson Financial

yardeni.com

#11

Earnings growth is

highly cyclical.

(12)

-1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 0 200 400 600 800 1000 1200 1400 1600 1800 2000

0 200 400 600 800 1000 1200 1400 1600 1800 2000

NEW IMPROVED STOCK VALUATION MODEL

5-year earnings growth weight _____________

.25

.20

.10 .25

.20

.10

S&P 500 Index

Fair Value* Jul

* 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.

yardeni.com

#12

This New Improved

Model builds on the

simple one by

adding variables for

long-term expected

earnings growth and

risk.

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 10 15 20 25 30

10 15 20 25 30

Jul

LONG-TERM CONSENSUS EARNINGS GROWTH* (annual rate, percent)

S&P 500

S&P 500 Technology

Ex Technology

* 5-year forward consensus expected S&P 500 earnings growth. Source: Thomson Financial

yardeni.com

#13

Long-term earnings

growth expectations

rose sharply during

1990s. Now they

are coming back

down to the Planet

Earth.

(13)

-1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -5 0 5 10 15 20 25 30 35 40

-5 0 5 10 15 20 25 30 35 40

Jul

MARKET’S WEIGHT FOR 5-YEAR CONSENSUS EXPECTED EARNINGS GROWTH* (percent)

Average = 13%

Weight market gives to long-term earnings growth ________________________________________ value > 13% = more than average weight

value < 13% = less than average weight

* Moody’s A-rated corporate bond yield less earnings yield divided by 5-year consensus expected earnings growth.

yardeni.com

#14

Investors have on

average over time

subtracted 13% of

their long-term

earnings growth

expectations from

the corporate bond

yield to determine

earnings yield.

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 .8 .9 1.0 1.1 1.2 1.3 1.4 1.5 1.6

.8 .9 1.0 1.1 1.2 1.3 1.4 1.5 1.6

Jul

S&P 500 PEG RATIO

P/E ratio for S&P 500 divided by 5-year consensus expected earnings growth*

Average = 1.2

* P/E using 12-month forward consensus S&P 500 expected earnings and prices at mid-month. Source: Thomson Financial

yardeni.com

#15

Historically, S&P

500 sold at P/E of

1.2 times long-term

expected earnings

growth, on average,

with quite a bit of

volatility.

(14)

-1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 6 7 8 9 10 11 12

6 7 8 9 10 11 12

8/10

CORPORATE BOND YIELD (percent)

A-Rated

* Source: Moody’s Investors Service

yardeni.com

#16

Corporate bond

yield variable in

New Improved

Model captures risk

that earnings will be

weaker than

expected.

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 50 100 150 200 250 300

50 100 150 200 250 300

8/10

CORPORATE SPREAD (basis points)

Moody’s A-Rated corporate bond yield minus 10-Year US Treasury bond yield

Average = 156

Source: Moody’s Investor Service

yardeni.com

#17

(15)

-#18

1995 1996 1997 1998 1999 2000 2001 -40 -20

UNITED STATES

Overvalued

Undervalued

1995 1996 1997 1998 1999 2000 2001 -20 -10

UNITED KINGDOM

Overvalued

Undervalued

1995 1996 1997 1998 1999 2000 2001 -100 -50

1995 1996 1997 1998 1999 2000 2001 -40 -20

1995 1996 1997 1998 1999 2000 2001 -30 -10

(16)

-#19

UNITED STATES (S&P 500)

Expected EPS* (dollars)

GERMANY (DAX)

Expected EPS (euros)

CANADA (TSE 300)

Expected EPS (Canadian dollars)

89 90 91 92 93 94 95 96 97 98 99 00 01 02 100

FRANCE (CAC 40)

Expected EPS (euros)

UNITED KINGDOM (FT 100)

Expected EPS (pounds)

* 12-month forward consensus expected operating earnings per share. Source: Thomson Financial

89 90 91 92 93 94 95 96 97 98 99 00 01 02 20

JAPAN (TOPIX)

Expected EPS (yen)

yardeni.com

(17)

-#20

STOCK VALUATION MODEL

Industrial Production (1987=100)

Expected Earnings Per Share* For S&P 500 (dollars)

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 5

Fair-Value P/E

Forward P/E

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 75

Fair-Value Price (ratio scale)

Stock Price Index (S&P 500) (ratio scale)

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 -40

* Source: Thomson Financial

yardeni.com

(18)

-#21

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 150 200 250 300 350

85 90 95 100 105 110

Jul

Expected Earnings Per Share for FT 100 (pounds)

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 7 9 11 13 15 17 19 21 23 25

7 9 11 13 15 17 19 21 23 25

Jul

Fair-Value P/E

Forward P/E

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1500 2300 3100 3900 4700 5500 6300 7100 7900

1500 2300 3100 3900 4700 5500 6300 7100 7900

Jul

Stock Price Index (FT 100) (ratio scale)

Fair-Value (ratio scale)

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -20 -10 0 10 20 30 40

-20 -10 0 10 20 30 40

Jul

Overvalued

Undervalued

yardeni.com

(19)

-#22

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 20 30 40 50 60

90 95 100 105 110 115

Jul

Expected Earnings Per Share for TOPIX (yen)

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 0 50 100 150

0 50 100 150

Jul

Fair-Value P/E

Forward P/E

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 0 500 1000 1500 2000 2500 3000 3500 4000 4500

0 500 1000 1500 2000 2500 3000 3500 4000 4500

Jul

Stock Price Index (TOPIX)

Fair-Value

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -100 0 100 200 300

-100 0 100 200 300

Jul

Overvalued

Undervalued

yardeni.com

(20)

-#23

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 75 100

Expected Earnings Per Share for DAX (Euros)

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 8 10

Fair-Value P/E

Forward P/E

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1000 3000

Stock Price Index (DAX) (ratio scale)

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -40 -30

(21)

-#24

1995 1996 1997 1998 1999 2000 2001 100 125

Expected Earnings Per Share for CAC 40 (Euros)

1995 1996 1997 1998 1999 2000 2001 11 13

Fair-Value P/E

Forward P/E

1995 1996 1997 1998 1999 2000 2001 1500 2300

Stock Price Index (CAC 40) (ratio scale)

1995 1996 1997 1998 1999 2000 2001 -40 -20

(22)

-1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 80 100 120 140 160 180 200

80 100 120 140 160 180 200

Jul

GLOBAL G6 EARNINGS INDEX* (Jan 1989=100)

* Half US and half G5 (Canada, France, Germany, Japan and United Kingdom) 12-month forward consensus expected operating earnings.

yardeni.com

#25

The yearly percent

change in our Index

of Global G6

Earnings is highly

correlated with the

growth of G7

industrial

production.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -4 -2 0 2 4 6 8

-15 -10 -5 0 5 10 15 20 25 30

Jul

GLOBAL G6 EARNINGS & PRODUCTION (yearly percent change)

G6 Earnings Index*

G7: Industrial Production

* Half US and half G5 (Canada, France, Germany, Japan and United Kingdom) 12-month forward consensus expected operating earnings.

yardeni.com

#26

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-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 10 15 20 25 30 35 40 45 50 55 60 65

70 80 90 100 110 120 130 140 150 160

8/10

S&P 500 EARNINGS & INDUSTRIAL PRODUCTION

S&P 500 Forward Earnings*

* 52-week forward consensus expected operating earnings per share. Monthly through March 1994, weekly after.

#27

Strong correlation

between US

industrial production

and S&P 500

forward earnings.

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 -20 -15 -10 -5 0 5 10 15 20 25 30

-20 -15 -10 -5 0 5 10 15 20 25 30

8/10 Jun

S&P 500 EARNINGS & PRODUCTION (yearly percent change)

S&P 500 Forward Consensus Earnings*

Industrial Production

* 52-week forward consensus expected earnings. Monthly through March 1994, weekly after. Source: Thomson Financial First Call

yardeni.com

#28

(24)

-86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 -15

S&P 500 EARNINGS & CAPACITY UTILIZATION

Total Capacity Utililzation (percent)

S&P 500 Forward Earnings* (yearly percent change)

* 12-month forward consensus expected operating earnings per share. Monthly through March 1994, weekly after.

Source: Thomson Financial.

#29

Growth in S&P 500

forward earnings

highly correlated

with US capacity

utilization rate.

Profits tend to

increase (decrease)

whenever utilization

rate is above

(below) 79%.

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 -20

S&P 500 EARNINGS & G7 INDUSTRIAL PRODUCTION (yearly percent change)

G7 Industrial Production S&P 500 Forward Earnings*

* 12-month forward consensus expected operating earnings per share. Monthly through March 1994, weekly after. Source: Thomson Financial

yardeni.com

#30

2-to-1 is the unusual

ratio between

growth in S&P 500

forward earnings

and growth in G7

production.

(25)

-1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -40 -30 -20 -10 0 10 20 30 40 50

-40 -30 -20 -10 0 10 20 30 40 50

Jul Jun

GERMANY: EARNINGS & ORDERS (yearly percent change)

Total Manufacturing Orders Forward Earnings*

* 12-month forward consensus expected operating earnings per share for DAX. Source: Thomson Financial

yardeni.com

#31

German corporate

profits highly

correlated with

factory orders and

business

confidence.

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -40 -30 -20 -10 0 10 20 30 40 50

-40 -30 -20 -10 0 10 20 30 40 50

Jul Jun

GERMANY: EARNINGS & IFO INDEX (yearly percent change)

IFO Business Climate Index Forward Earnings*

* 12-month forward consensus expected earnings per share for DAX. Source: Thomson Financial

yardeni.com

#32

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-1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 100 125 150 175 200 225 250 275

92 94 96 98 100 102 104 106 108 110 112 114 116 118 120

Jul

FRANCE: EARNINGS & PRODUCTION

Forward Earnings*

* 12-month forward consensus expected earnings per share for CAC 40. Source: Thomson Financial

yardeni.com

#33

Industrial production

is key variable

driving profits in

France and UK.

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 180 200 220 240 260 280 300 320 340

88 90 92 94 96 98 100 102 104 106 108 110

Jul

UNITED KINGDOM: EARNINGS & PRODUCTION

Forward Earnings*

* 12-month forward consensus expected earnings per share for FT 100. Source: Thomson Financial

yardeni.com

#34

(27)

-1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 20 30 40 50 60

90 95 100 105 110 115

Jul

JAPAN: EARNINGS & PRODUCTION

Forward Earnings*

* 12-month forward consensus expected operating earnings per share for TOPIX. Source: Thomson Financial

yardeni.com

#35

Japan is falling into

recession again.

Weak yen boosts

exporters’ earnings.

But profits are likely

to weaken along

with economy.

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 20 30 40 50 60

-50 -25 0 25 50 75 100

Q2 Jul

JAPAN: EARNINGS & TANKAN BUSINESS CONDITIONS

Tankan Business Conditions: Major Manufacturers

(diffusion index) Forward Earnings*

* 12-month forward consensus expected earnings per share for TOPIX. Source: Thomson Financial

yardeni.com

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-The information and opinions in this report were prepared by Deutsche Bank or one of its affiliates (collectively “Deutsche Bank”). This report is based upon information available to the public. The information herein is believed by Deutsche Bank to be reliable and has been obtained from sources believed to be reliable, but Deutsche Bank makes no representation as to the accuracy of completeness of such information. Deutsche Bank and/or its affiliates worldwide may be market makers or specialists in, act as advisers or lenders to, have positions in and effect transactions in securities of companies mentioned herein and also may provide, may have provided, or may seek to provide investment banking services for those companies. In addition, Deutsche Bank and/or its affiliates or their respective officers, directors and employees hold or may hold long or short positions in the securities, options thereon or other related financial products of companies discussed herein.

Opinions, estimates and projections in this report constitute Deutsche Bank’s judgment and are subject to change without notice. Prices and availability of financial instruments also are subject to change without notice. This report is provided for informational purposes only. It is not to be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction in which such an offer or solicitation would violate applicable laws or regulations.

The financial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions using their own independent advisors as they believe necessary and based upon their specific financial situations and investment objectives. If a financial instrument is denominated in a currency other than an investor’s currency, a change in exchange rates may adversely affect the price or value of, or the income derived from, the financial instrument, and such investor effectively assumes currency risk. In addition, income from an investment may fluctuate and the price or value of financial instruments described in this report, either directly or indirectly, may rise or fall. Furthermore, past performance is not necessarily indicative of future results.

Unless governing law permits otherwise, all transactions should be executed through the Deutsche Bank entity in the investor’s home jurisdiction. In the U.S.

this report is approved and/or distributed by Deutsche Banc Alex. Brown Inc., a member of the NYSE, the NASD and SIPC. In the United Kingdom this report

is approved and/or distributed by Deutsche Bank AG, which is regulated by The Securities and Futures Authority (the “SFA”), is not for distribution to private

customers (as that term is defined under the rules of the SFA) and no financial instruments referred to herein will be made available to any such private customer. In jurisdictions other than the U.S. and the U.K. this report is distributed by the Deutsche Bank affiliate in the investor’s jurisdiction, and interested

parties are advised to contact the Deutsche Bank office with which they currently deal. Additional information relative to securities, other financial products

or issuers discussed in this report is available upon request.

No part of this material may be copied or duplicated in any form or by any means, or redistributed, without Deutsche Bank’s prior written consent.

Deutsche Bank Equity Sales Offices, Americas

Deutsche Banc Alex. Brown Inc.

950 East Paces Ferry Road Suite 3320

Atlanta, GA 30326 (404) 812 6800

1 South Street Baltimore, MD 21202 (410) 727 1700

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Boston, MA 02110 (617) 988 8600

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New York, NY 10019 (212) 469 5000

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Third Floor Denver, CO 80206 Tel: (303) 394 6800

Deutsche Bank Securities Limited

222 Bay Street, Suite 1100 P.O. Box 64

Toronto-Dominion Centre Toronto, Ontario M5K 1E7 (416) 682 8000

Deutsche Bank Securities Limited.

999, de Maisonneuve Blvd., West

Suite 825

Montreal, QC H3A 3L4 (514) 875 2252

Deutsche Bank

Correctora de Valores Rua Alexandre Dumas 2200 CEP 04717-910 São Paulo SP Brazil

Tel: (5511) 5189 5000

Deutsche Bank SA - Mexico

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Col. Lomas deChapultepec, 11000 Mexico, DF

Tel: (525) 201 8000

Deutsche Bank SA - Argentina

Tucuman 1, 14th Floor C1049AAA

Buenos Aires, Argentina Tel: (5411) 459 02968

Deutsche Securities Corredores de Bolsa Ltda

El Bosque 130, Las Condes Santiago, Chile

Tel: (562) 337 7700

Deutsche Bank Equity Sales Offices, International

Deutsche Bank AG

Taunusanlage 12 3rd

Floor

Frankfurt, Germany 60325 (49) 69 9103 7597

Deutsche Bank AG Geneva

7, Rue Du Rhone, 1st

Floor Geneva, Switzerland, 1204 (41) 22 319 4000

Deutsche Bank AG London

1 Great Winchester Street London EC2N 2EQ United Kingdom (44) 207 545 4900

Deutsche Bank AG Paris

3, Avenue de Friedland 75008 Paris, France (33) 1 5375 2446

Deutsche Securities Australia Limited

Level 19, Grosvenor Place 225 George Street

Sydney, NSW 2000 Australia (61) 2 9258 1234

Deutsche Securities Limited, Tokyo

2-11-1 Nagatacho, 20th

Floor Sanno Park Tower

Chiyodu-ku, Tokyo 100-6171 (813) 5401 6990

Deutsche Bank AG Zurich

Bahnhofquai 9-11