Deutsche Banc Alex. Brown Global Strategy ‘August 13, 2001 Asset Valuation & Allocation Models r. Edward Yardeni Chie! Investment Strategist (41) 212 4695715 edward: yardeni@ab com Amati F Quintana Equity Strategy Analyst (et) 212 469.5713, tol quintans@db.com Deutsche Bank- Introduction - L Fed’s Stock Valuation Model How can we judge whether stock prices are (oo 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- vversus-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 itis 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 irational exuberance has unduly escalated asset values, which then, become subject to unexpected and prolonged contractions...."' He did it again on February 26, 1997.? 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 Feds Monetary Policy Repost to the Congress, which accompanied Mr. Greenspan’s Humphrey- Hawkins testimony on July 22, 1997.* 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 focward eamings yield (FEY)—ic., the ratio of expected operating earings (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 (ic,, 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-eamings 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: Spa eralreserve, speeches! 1996/1962 * “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 quest Page 2 / August 13, 200/ / Deutsche Bane 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 deciine in interest rates. As a result, the yield on ten- year Treasury notes now exceeds the ratio of twelve-month-ahead eamings 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 earings growth over the next three to five years, The average of these expectations has tisen fairly steadily since early 1995 and currently stands at a vel not seen since the steep recession of the eatly 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 comected 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 comected by tising yields, lower earings expectations, oc 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 tise: 1) The market was extremely undervalued from 1979 through 1982, powerful rally that lasted through the summer of 1987. setting the stage for a 2) Stock prices crashed after the market rose (o a record 34% overvaluation peak during September 1987. 3) Then the market was undervalued in the late 1980s, and stock prices rose. 4) Inthe 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 actualy fairly valued during December 1996 when the Fed Chairman worried out loud about irrational exuberance. Deutsche Bane 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 comporations 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-be LTEG where CBY is Moody's A-rated corporate bond yield, LITEG is long-term expected earnings growth, which is measured using consensus five-year earnings growth projections, /B/EIS International compiles these monthly. The “tb” coefficient is the ‘weight thatthe 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-be 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. IIL. Back To Basies 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 Bane Alex. Brown US Stock Valuation & Allocation Modelsimplicit assumptions in the stock market about the weight given to Iong-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 mote sophisticated and complex models, The ed model is not a market-timing (ool. 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 eam 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” stocl/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, 1 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 Bane Alex. Brown US Stock Valuation & Allocation Models / August 23, 2001 / PageSoper HOREDOTTY ¥ MoNEMTEA ISSY UMOIG “xOTY DUEG DDSI / 190C ET ISNENY / 9 BEE ED YARDENI'S ASSET ALLOCATION MODEL: STOCKS/BONDS. (for large equity funds) Stocks overvalued when greater than zero Stocks undervalued when less than zero yardeni.com 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 - UOTPLOTTY }2SSV -2s] - Valuation Model - 1725 FED'S STOCK VALUATION MODEL 185 (ratio scale) 1425 1278 1125 975 — SaP 500 Price Index 825 678 Fair Value Price” 528 208 ‘According to the Fed model, when stock prices are sects} 75 overpriced, returns 78 TaTecTenTaaTeaTeaTas a5" e7Tes oT ooToi Tua aa ea" esTssTorTosTosToa"oxTazToat”* pwerBlicen tom * 12:month forward consensus expected S&P 500 operating earings per share divided by likely to be subpar {fear US Treasury bond yd Monthy trough Mar 1994, week ater rerine neni oa: months, es Better-than-average 70-7 returns tend to FEDS STOCK VALUATION MODEL come from ween co underpriced markets. wo ao ao atl Overvalued wo 10 Se el Undervalued 20. pardenicom 404 7aT eo" ai e2"eaTesTe5T e567 lea! ea 90791 927 saTeaT e576! 9798 98" G00: T02T 03 * Ratio of S&P 500 Index to ite Fair-Value (52.week fommard consensus expected cperating sarings per share divided by the 10-year US Treasury bond yee) 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 ‘8 18 ‘S8P 500 EARNINGS VIELD & BOND VIELD v4 Liz Lis bss This chart appeared — Forward Earnings Yield" in the Fed's July pit 10-Year US Treasu 1997 Monetary Bond Yield " bs Policy Report to the v2 Congress. It shows Ls, avery close Ee correlation between the earnings yield of re the stock market fe and the bond yield, L; Another, more lL, familiar way to look Ee at it follows. a0 “ Ls of La : yerdericon | ToTapT ai aa ea Teal a 86 a7 Te6 78 G07: TaeT 9a" 4735 o6T er Toa o—T 0001 To2l oa * 12:month forward consensus expected S&P 500 operating earnings per share divided by EaP 500 Index. Mortnly through Maren 1994, weakly ater Source: Thomson Financial 6 2s 26 os] PES BOND VELD faze a bos a Loa The S&P 500 P/E 2} — Ratio of S&P 500 Price to Expected Earnings" ano Poe (using expected Fair-Value P/E=Reciprocal of 20 earnings) is highly 0-Vear US Treasury Sond Yield Lio correlated with bse reciprocal of the biz bond yield. Lis bss bss L +3 | +2 Lio ‘ fo ta? ¢ fe Mol BS | mo AS fi : jardetcom | & 7oTaoTei Ta2TeaT eT asl o5 e736 Ta9 "e091 To2T ea" 94 a5 Toe 7" 90790700" 01 Toe" oo * 42.month forward consensus expected S&P 500 operating eamninge per share. Monthly through March 1994, weekly after Source: Thomeon Financial Page 8 / August 13, 2001 / Deutsche Bane Alex. Brown Asset Valuation & Allocation Models4 | oof sf so 4 co wo v0 ao 4 ad 20-4 4 - Earnings - “SAP 500 EARNINGS PER SHARE (analysts’ average forecasts) Consensus Forecast for 2001 Consensus Forecast for 2002, Font ag pane oe Se Consensus Forecast for 2000 v 7 Wr Ww Hi 7 1 2000 2001 * S2-meek forward consensus expected S&P 500 operating earnings per share Source: Thomson Financial a7 “SAP 600 EARNINGS PER SHARE, ACTUAL & EXPECTED ‘S&P 500 Earnings Per Share — Forward Earnings pushed 52-weeks ahead) Operating Earnings (quarter sum) 104 * 52.meek forward consensus expected S&P 500 operating earnings per share, Monthly through March 1994, weekly after Source: Thomeon Financial ardent com F 980!196611987"ro0a) 160977 9901r601 1902) 99al ond ces) s995! 997 100811 99012000/2001"2002!2000) Expected forward earnings is a time-weighted average of current and the coming years’ consensus forecasts. Bottom-up 52-week forward expected earnings tends to be a good predicator of actual earnings, with a few significant misses. Deutsche Banc Alex, Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 97s - Earnings - #8 no 4 ‘SaP 500 CONSENSUS OPERATING EARNINGS PER SHARE {analysts Bottom-up forecasts) Consensus Forecasts — 12-month forward Annual estimates ‘Actual 4 sum yordentcon 75 L7o Les so Las 50 fas bas -30 Les Too Tyao1 T voae yena veo 7 Source: yarderi.com. Do not reprint without permission. jas ya56 Tar ' veoe T ye08 ™ 2000 T2001 T 2oce 20 20 Analysts always start out too optimistic about the prospects for earnings. 28 20 ad od ‘SBP 500 CONSENSUS OPERATING EARNINGS PER SHARE {enalysts’ bottom-up forecasts, ratio scale) Consenus Forecasts — 12:month forward seme Annual estimates ‘Actual 40 sum ea sardenicom 25 [20 Fes 10. 97a" 3979 1980" vo8r "1982" 1989 roa 1905 "1965" 1087 | vo8e T1000 1000 T 1e91 Page 10/ August 13 Source: yardeni.com. Do not reprint without permission, 2001 / Deutsche Bane Alex. Brown Asset Valuation & Allocation Models 10- Earnings - #10 °°" SaP 600 EARNINGS PER SHARE a4 Consensus Growth wo] Forecasts" yenden.com TW 184 o Ww v T T 2000 2001 * Based on consensus expected S&P 500 operating eamings fer years shown, Source: Thomson Financial a ‘S&P 500 OPERATING EARNINGS PER SHARE™ (yeary percent change) me es! [Lr] Consensus Forecast (Proforma)* ao 24 20-4 a4 10 yardenicom 2002 yess) yeas 1 190s ' voor ' a9 1 voa9 1 2000 | 001 * S&P 500 composition is constantly changing, Actual data are not adjusted for these changes. Proforma forecasts are same-company comiparisions. Source: Thomson Financial 15 The data on consensus expected earnings can be used to derive consensus eamings growth forecasts. Earnings growth is highly cyclical Deutsche Bane Alex, Brown Asset Valuation & Allocation Models / August 23, 2001 / Page 11- New Improved Model - #12 2000 2000 NEW IMPROVED STOGK VALUATION MODEL 1200-4 | :200 This New Improved '®0-] [1900 Model builds on the simple one by aot — sap 500 Index F100 adding variables for oo Fair Valust oe long-term expected S:year earnings rowih weight earnings growth and ,,,.. | a ZI —_ risk. 25 Nn. 004 wm 20 [800 wm 10 coo 00 “04 400 zoo L200 ardent.com © Tear anal raaaT reno 001 02 roosT rao? 1005 tose 1007 ea! ovo !2000T 2001 Toon? ° Toa7 a8! roa 1680719517 1882T 9a" To5« T0psT Te86 1987 988 9982000! 2001 T2on2 * Fair Value is 12-month forward consensus expected S&P 500 operating earnings per share divided by diference between Moody's Arated corporate bond yield leas actin (as shown Shove) of year consensus expected earnings growl Source: Thomson Financial #13 0 20 TONG: TERM CONSENSUS EARNINGS GROWTH (ennval rate, percent) Long-term earnings — saP 500 growth expectations “| w= S8P 500 p> rose sharply during Technology 1990s. Now they Hoist are coming back Technology down to the Planet 2 20 Earth | bas i ardenicon| 19877 166877965" 1990" 091 va52 16537 1964 995 1986! 1997 "1858" 1990 2000" 200% T2002 Page 12/ August 13 * S:year forward consensus expected S&P 500 eamings growth. Source: Thomson Financial 2001 / Deutsche Bane Alex. Brown Asset Valuation & Allocation Models- New Improved Model - 4 TWARKETS WEIGHT FOR 5-VEAR CONSENSUS EXPECTED EARNINGS GROWTH" (percent) Weight market gives to long-term earnings growth value > 13% = more than average weight value < 13% = less than average weight Investors have on average over time subtracted 13% of their long-term earnings growth expectations from the corporate bond yield to determine earnings yield. yardenizom 1ea7 aaa! 7980" 1990" 9017 Tose" 1908 16961 T9857 Te96" 857 Mesa” roe "2000 "20017 2002 * Moody's A-rated corporate bond yield less earnings yield divided by 5-year consensus, expected eamings growth. #15 ‘S&P 600 PEG RATIO PIE rato for S&P 500 divided by 5-year consensus expected earnings growth" Historically, S&P 14 500 sold at P/E of 1,2 times long-term 13 expected earnings growth, on average, with quite a bit of volatility, Average ardent com [986770871 988" 1980" 1090! 19917 1602" 19037 190471995" 906" 99771988" 1990"2000" 2001 2002! * PIE using 12month forward consensus S&P 500 expected earnings and prices at mid-month, Source: Thomson Financial Deutsche Bane Alex. Brown Asset Valuation & Allocation Models August 13, 2001 / Page 13Corporate bond yield variable in New Improved 2 - New Improved Model - #16 n wo ‘GORPORATE BOND VIELD (Gercont) ‘ARated 210 yordentcon 12 I-10 Model captures risk that earnings will be weaker than expected, Page 14/ August 13 Toa7 e887 oso" 1860) 19817 vasa" 1808) 1864 1985" 1e08) 1967" ToNBT 18082500! 2001 T2002 * Source: Moody's Investors Service #7 300 CORPORATE SPREAD (basis points) oxo} Moody's A:Rated corporate bond yield minus 10-Year US Treaeury bond yield 2/10 Average = 156 sardenicomt 200 L2s0 L200 L 120 L 100 79871 19981 19897 1980" 1991 1a82 "990716041 1905 996 1907 "998" 199972000! 2001 "2002 ‘Source: Moody's Investor Service 2001 / Deutsche Bane Alex. Brown Asset Valuation & Allocation Models 50- Global: Stock Valuation - 0 Fs eo UNITED STATES wo bso wo overvalied Fo 24 Baus ° ° ey Undervalued aa sia T T T a 78 To86 7 708 102 200 Bor 2 20 UNITED KINGDOM 2] overvalued Leo vo AL Lio of ° an Undervalued V4 \nu bi 2 : : : : 20 To8s Tee 7 Toee Tae 700 aor 200 200 JAPAN 04 E iso theae Overvalued ei wo Eso ° ° oF Undervalued su BO -t00 ; ; ; 100 To98 T0968 7 Toe8 7 zo00 aor Ps eo GERWANY wo Feo wo overvakied Fo 24] E20 ° \ ° 204 Undervalued Ne fF -20 0 40 78 To%8 787 Toe T0808 Eo aor 0 eo FRANCE a a Ovenalued ba ° a uw Ty a Undervalued te 40 T T T 40 708 To96 7087 7088 Toe 7200 aor x0 so CANADA | overvawed ts oJ Lio Undervalued sranletcom 0 T T T T T T i To98 To86 7 7 Te80 2000 201 Deutsche Bane Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 15- Global: Expected Earnings* - #9 6 328 UNITED STATES (S&P 500) (GERMANY (DAX) }-200 eo i bars ss ul }-280 20 }-225 Expected EPS" Expected EPS “7 (dollars) (euros) 200 i. bi75 b 120 3s } 125 al b 100 i lealeutar tastes loalas tos larleales oolor! Tolan lealeatastoslorleslestalo toss aetooTor ea teatostestestertestea Tooter Toe! laalaolei lea! ealoa Teel eater teat ea too Tos To 550 280 fas_] CANADA (TSE 000) FRANCE (GAC 40) | 260 200-4 i as f-240 a Lui Erected EPS ae aes] Expected EPS i (Canadian dollars) wo] f-200 a5 f 180 aso ae f 160 200] f 140 ors ooo | f 120 225 TeT oT ai Ta Tea on Ton Tea Tor eal oa TooTort Toole Tea Teal ea ToaToatorloatosToot ‘08; woTooT or ea Toston leet ester testes Tooter toa! laalagl artes lates Testes ter oa tea oo Tor tes 260 70 UNITED KINGDOM (FT 100) JAPAN (TOPIX) 340] 20-4 : re 200] Expected EPS Expected EPS. (pounds) (yen) lL s0 ul 20-4 260-] bso 20-4 220] loo 200 pardeni.cont 190 t 20 ‘e970 7 91 e2 To3T ox Tes T 05 Te7T 08" e9 T0001 Toa aT 907162 Te3T os TesT asl or Teal e0T colo Voz + 42.month forward consensus expected operating earnings par share. Source: Thomson Financial Page 16/ August 13 2001 / Deutsche Bane Alex. Brown Asset Valuation & Allocation Models- Global: United States (S&P 500) - #20 150 70 ‘STOCK VALUATION MODEL 1304 bso 1304 Ju i904 bso Industrial Production v0 (1987-100) 1104 100] = pat }-20 -} — Expected Eamings Per Siare* ee aot For S&P 500 (dollars) TT a5 Ter Tea bea Vas Tan Toa Taras Ten Tet Ta5 Toa Tes Tos Tartan TeoTooTorToat me teo tar tazlaalaslantas tar taal aplaol ele loatastasleslarlealast onto; laa 20 30 a Fes — Fair-value PE 24 F20 Forward PIE 4 Fis wf Fi0 5 Ta Tan Taa oa Tes Tes tar tas TaaTaoT T Tax Tag Ter oa Tea Too Tor teat ® me teo tar taal aalas lentes tar taal aplaol eile loatastasleslarlealastooloi a 1925 1825 1754 E1475 rsd wt Bias — Stock Price Index (S&P 500) m4 (ratio scale) sm Falt-Value Price sos (ratio scale) F-s20 Ty T oo Ter Tea tea es Fan Toa Tar tes Tea Tent To Tox Ten Tos Ter Tea TeoTooTortoat met eo te taal aaa las tas tart esl apt eol or lea lesley! axl esl erlealestooloi os 70 70 oo Foo xo bso | Feo at Overvalued fa aod wo of “04 | Undervalued 04 f--20 yardentcom =f Arrailanelcertlinacestlreat en lreeiien lenis lool Treai-oat Pentan:lrariliee eatliooleoitlesiace: me eo te taal aaa las tas tart esl ap lector lealostay! axes ler! eales! ool oi a * Source: Thomson Financial Deutsche Bane Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 17- Global: United Kingdom (FT 100) - m STOOK VALURTEN MODEL 105-4 Jul + nus Prodton (1995=100) é os « — swected Eaming Pr Share agri bist T T T T T T T T T T T T T T fate sem aus Tam Tan Tos ines Tame Tees Tress Vicar Tass To Tame Tor Ta nf Les ay — Fair-value P/E car 19a T 1988 7 1980 ' 1901 ' 1902 ' 190s ‘1984 ' 100 T 1806 T 987 ' iea8 ' 1989 2000 ' 2001 ' 2002 0 rc0 ere é [stn oa — sioskPice index 100 eee es Faivaue sao] | seco (aoa) awe [co 1500. T T T T T T T T T T T T T T fee com aes Tm Tae Tone ies aoe Tics Trae Teer Tae Ue Tao aor Ta . 1 o| Lo overahed ° hy ° as Undervalued ae oe T T T T T T T T T T T T T T oe com aus Tom Tae Tone Ties aoe Tics Trae Teer Tae Ue Tao bor 7 am + sauce. Thomson Finacial Page 18 / August 13, 2001 / Deutsche Banc Alex. Brown Asset Valuation & Allocation Models- Global: Japan (TOPIX) - #22 us 0 ‘STOCK VALUATION MODEL 104 — Expected Earnings Per Share for TOPK iyen) st re 105-4 *>" Industil Production (1995-100) A 1004 say Ww : 7 30 os % T T T T T T T T T T T 20 veer 1 vo8e 1 1o0 1 1950 1 005 soos 1 907 1 1050 1 1009 1 2000 ' aoov 1 aoae 10 180 — FairValue Pie 100 100 Forward PIE [50 ° T T T T T T T T T T T ° veer 1 vo8e ' 1o0 1 1950 1 005 1 soos 1 907 1 1050 1 1008 1 2000 1 aor 1 coca 4500 4800 4000+ 4000 3500+ f-3500 3000 + f-3000 — Stock Price Index (TOPIX) 2500+ f-2500 oo FaiValue 2000+ f-2000 1800 f 1800 Jul 1000+ f 1000 {500 ° T T T T T T T T T T T ° oer 1 voee 1008 1 1901 1 005 1 1006’ 1907 1 1050 1 e091 2000 ' aoor 1 coca 300 300 Ovewalued 200 200 100 }100 o o Undervalued yondenicom i i T T T T T T T T T T T oo 961 1 veo’ 1008 1 1901 1 1005 1006’ 1907 ™ 1050 1 1009 1 2000 ' aoo1 1 coca * Source: Thomson Financial Deutsche Bane Alex. Brown Asset Valuation & Allocation Models August 13, 2001 / Page 19- Global: Germany (DAX) - #23 120 328 ‘STOCK VALUATION MODEL a 7] bars }-250 1104 Industrial Production }-225 200 bi75 100-4 jena Yo Expected Eamings Per Share } 125 for DAX (Euros) eae % T T T T T T T T T T T 7 vor 1602 1 1982 1 voor | 90s 1 4908 | voor’ vos 1 18a 1 2000 ' co01 | a00e 3s 34 x4 bs2 F20 Fee F26 Fos E22 E20 Fie Fis Fas Fiz F 10 8 T T T T T T T T T T T 8 vor 1602 1 1952 1 voor | 90s 1 908 | voor’ vos 1 18a 1 2000 ' co01 | a0o2 411000 111000 000-4 f-s000 7000-4 7000 Pou J — Stock Price Index (DAX) i and (ratio scale) ante Fair-Value 8000 (ratio scale) fs009 1000 T T T T T T T T T T T fae voor 1 1992 1 1050 1 voor |’ 1900 1 1908 | voor’ 1008 1 1809 7 2000 ' coor ' co0e 70 70 oo Foo xo bso oF Overvalued po xo aod wo of “10 Undervalued 204 0] yardentcom a T T T T T T T T T T T voor 1992 1 1050 1 yor | 1905 1 1908 1 voor ' 1000 1 1809 7 2000 ' 001 | ao0e * Source: Thomson Financial Page 20/ August 13, 2001 / Deutsche Banc Alex, Brown Asset Valuation & Allocation Models,- Global: France (CAC 40) - a 0 = "= srOGK VALUATION NOBEL uw beso ne] a ne] E vas re] E 20 104 + Indust Production ve | a woe | to] E iso — expec amings Pr Share reas e EUS E sas 100 1995 + 1996 : 1997 : 1998 : 1999 H 2000 2001 » = a fA, ber os] — Fair-value PE / x bes 23) Forward P/E i Baad a Eo: vo E v4 Ew vo Es of Es " : ; ; 1 rr Tos er ree = Toon ar 100 ro%0 Ro] me oJ [esos sso | [soo 4700 -| — Stock Price Index {CAC 40) Sul TL aro9 fate oc} soon | L sos Foicvaue ovo ay [avo 200 | | 200 v0 ; ; ; 100 Tos er re = ey ar © ‘ aa wl Overaled L ° Sf Put, Undervalued io yntnicon ieee T T T T ee Tos ar re =e Teen 01 * Source: Thomson Financial Deutsche Bane Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 21The yearly percent change in our Index of Global G6 Earnings is highly correlated with the growth of G7 industrial production Page 22/ August 13 - Earnings & Output: G6 - #25 200 200 GLOBAL G6 EARNINGS INDEX" (dan 1989-100) veo Lse0 ul 160 L160 wo bs40 1204 } 120 100 300 yordentcon % T Tosa Taos Treas Tross Treor Mte0e Tieoe Vanco Ta001T 7 ovo Tya01 ' voae yen8 Tiass' yeas Taos" voor! ye08 T 1a59 ' 2000 2001 T 2002 * Half US and half G5 (Canada, France, Germany, Japan and United Kingdom) 12-month forward consensus expected operating earnings, #26 x a GLOBAL G6 EARNINGS & PRODUCTION (early percent change) — G6 Eamings Index (G7; Industrial Production sardentcom 990 "901 1992" ve09 "904 T ve05 "1008 T1997 ' ve98 Te00 T 2000 T2001 T 2oce * Half US and half GS (Canada, France, Germany, Japan and United Kingdom) 12-month forward consensus expected operating earings. 2001 / Deutsche Bane Alex. Brown Asset Valuation & Allocation Models- Earnings & Output: US - #27 “SAP 500 EARNINGS & INDUSTRIAL PRODUCTION 1404 — saP 500 Forward Eamings* 1204 Industrial Production (1992 100) 120-4 104 100-4 oo} 80) olay aa aa ee a5 as Ta7 eal eal ool oi Tea teal ea Tan eel ar oa os oo / or TeaTeaTos Strong correlation + S2.week forward consensus expected operating earings per share. Monthly through between US Stree: omnson Pnanal industrial production and S&P 500 a forward earings. ‘S&P 500 EARNINGS & PRODUCTION (Yearly percent change) — SAP 500 Forward Consensus Earnings” Industrial Production 15 20 071 "a2 eaTeeTe5Ta57e7! eal e9! 0701 "92TsaT eT a5 Te6T orl oa" aT 07 1 02 oaT os * S2.week forward consensus expected earnings. Monthly through March 1994, weekly ater, ‘Saurce: Thomson Financial First Call Deutsche Bane Alex. Brown Asset Valuation & Allocation Models / August 13, 2001 / Page 23Growth in S&P 500 forward earnings highly correlated US capacity utilization rate. Profits tend to increase (decrease) whenever utilization 734 rate is above (below) 79%. 2-to-1 is the unusual ratio between growth inS&P 500 ® forward earnings and growth in G7 production. Page 24 / August 13 - Earnings & Output: US - #29 es ed ed eo ef 7 | | ‘SAP 500 EARNINGS & CAPACITY UTILIZATION — Total Capacity Utilization (percent) S&P 500 Forward Eamings* (veatly percent change) 25 ee tarlaalastaatarleataa ealestostarl estes! oolor taal aslon * 12.-month forward consensus expected operating earnings per share. Monthly through March 1994, weekly after, Source’ Thomson Financial #30 ‘S8P 500 EARNINGS & G7 INDUSTRIAL PRODUCTION (early percent change) 32 bes fea Leo Ls — SaP 500 Foard Eamings* re (G7 Industrial Production sardentcom ao e1 a2 ea eel es "961 e7 eae 907 91 V2 TeaT es Ta5T a6 T or Toa e000 01 Toe * 42.month forward consensus expected operating earnings per share, Monthly through March 1994, weekly after, Source. Thomson Financial 2001 / Deutsche Bane Alex. Brown Asset Valuation & Allocation Models- Earnings & Output: Europe - ‘GERMANY. EARNINGS & ORDERS (yeary parcent change) — Fonard Earnings" Total Manufacturing Orders yordenizom Teor" 1992" 90a" vasa) v905 / vo08 vo8r | voo8 7 yo0e 7 2000 * 12:month foward consensus expected operating earings per share for DAX. ‘Sauree: Thomson Financial #92 GERMANY. EARNINGS & IFO INDEX (Yearly percent change) — Fonard Earnings? --" IFO Business Giimate Index ardent com vos! T vo02 7 ve00 T v094 T1098 T1808 ' 1907! 1908 1090 * 12.month foward consensus expected earnings per share for DAX Seurce: Thomson Financial German corporate profits highly correlated with factory orders and business confidence. Deutsche Bane Alex. Brown Asset Valuation & Allocation Models August 13, 2001 / Page 25Industrial production is key variable driving profits in France and UK. Page 26/ August 13 - Earnings & Output: Europe - #33 120 278 FRANCE: EARNINGS & PRODUCTION ne ne ui [-250 ned — Forward Earnings" ie — [225 110-4 Industrial Production (1995-100) 100 | 200 106-4 10s bars 102 100 Fss0 ood vo fies od MS yordentcon % Terao ilFseeat-hoaa! ioon'l aecat linear linens Teisaatlroonat ronal 100 Toor) 1992" tesa! i9a8 toss) vose veer vepa T voa0 7 p000 7 2001? 2002 * 12-month forward consensus expected earnings per share for CAC 40, Source: Thomson Financial #34 10 240 UNITED KINGDONT EARNINGS & PRODUCTION 100 }-320 106-4 Jul toa] |-200 102 +280 100 }-260 oo col — Forward Earnings’ ta ++" Industrial Production 4 (199: }-220 2 L200 oof sardenicom = Teagan llesaear creaat lioae li iaael voardleqaoe sont leonant rane tied vost ve02 T1993 T1904 7 805’ s908 y907 ' 1998 T vos T 2000 T 2001 T 2002 + 42-month forward consensus expected earnings per share for FT 100 Source: Thomson Financial 2001 / Deutsche Bane Alex. Brown Asset Valuation & Allocation Models105-4 100-4 - so 100. v0 2s 2s - Earnings & Output: Japan - #95 JAPAN: EARNINGS & PRODUCTION — Forward Eamings* Industrial Production (1995100) ul yordenizom ‘oor t 2002 20 Teor" 1992" 90a" vasa) v905 / vo08 vo8r | voo8 7 yo0e 7 2000 * 12:month foward consensus expected operating earnings per share for TOPIX. ‘Source: Thomson Financial #96 60 JAPAN: EARNINGS & TANKAN BUSINESS CONDITIONS, — Fonvard Earnings — + Tankan Business Conditions: Major Manufacturers (aiffusion index) vos vo02 1 1909 1 1094 7 y098 7996 oar 1 v008 } 1090 * 12.-month foward consensus expected earnings per share for TOPIX, Seurce: Thomson Financial Japan is falling into recession again. Weak yen boosts exporters’ earnings. But profits are likely to weaken along with economy, Deutsche Bane Alex. 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The report e rowed for nfaematiana! purposes any is nots bs coneted mean oo DiWsrsell ot solscaion of a fers buy ore any tan inttamans or 19 partspate ny pala alg stetagy ih sny fseteion ia wish Sith anomr or solctanon woul veste apg iabieaws or tulatons The financial insiumente dissed thi ropon may not be sable fra ivestors and investor must make thet own investment dsisions sing their ‘danomningted ins currency otter nan an mwostar® curency- a change in exchange rates may eaversly affect he pie or vals of ort income Served fom, the fnencalinsrunsnt, and eh investor pfetvelyaswimos eure rik. In'adhoan, ineometrom ay snvesment may fictusto anh pies ‘ate of inatl mera doen nthe pon, om deacty or ast, mayne oa. Fartormore, pot prtorance mnt novo naesv> Unless goverina lon permits otherwise, al trnascions show be oxecutod trough the Devt Sank ety i the vests hom juticion. tn he US. {hlavepbrt(s approved std datbuted by Beytache Bane Ales. Brown Inga inombor of ihe AVE, the NALD an SIE" Tn tno Unilod Kinga is foport, approved andor dated by Qeutaehe Bark AG whch fegtltat by tho Socrsic end Futuréa Aulhorty fina "SFA", not or dstnbuton to peeto Chstomors (ae tet form is fefined cer tho flew Sf tho SEA) and no ihancalintrumoate refered to here wl be mado sume so eny etch priete stor, jrttatne other ign ie U's an ho UK he ropt ie dingo yt Gave Berk aft nvr edition ee rtd pure ate sevlond fo comet the Deuach Gank office wil wick they curry al Adetionaliormaton relative to Secuntes, other nancial products Srieeuer ecunsed in tus report avaiable ypon request No port ofthis moterial may be copied or dpleated in my form or by sty means, or eitante, without Destsche Banks prior written coms. the aie The mformaton tera