We have been trying to build a pricing model for JPMorgan Chase (NYSE: JPM) since 2008. JPM is a company from Financial sector which “provides various financial services worldwide”. Lately, we presented on Seeking Alpha similar models for the following financial companies: Bank of America (BAC), Franklin Resources (BEN), Morgan Stanley (MS), Lincoln National (LNC), Invesco Ltd. (IVZ), Goldman Sachs (GS), and ACE Limited (ACE).
Our concept of stock pricing assumes the possibility to decompose a share price into a weighted sum of two consumer price indices (CPIs). The background idea is simple: there is a potential trade-off between a given share price and goods and services the company produces/provides. For example, the energy consumer price should influence the price of energy companies. In this post, we assume that some set of consumer prices (or the relevant consumer price index, CPI) drives JPM stock price. The change in these consumer prices is transferred into the share price. Our first task is to find this driving CPI. Obviously, the influence of this driving CPI depends on the overall market evolution. For example, a market rally makes almost all companies to grow together with the market and market crashes hit all companies as well. Our model expresses the net market change by one reference CPI, which should best represent the overall dynamics of the changing price environment for the modeled company. One can use the market indices (S&P 500, Dow Jones, NASDAQ 100, etc.) instead of the reference CPI. In some cases, these indices may provide a better reference than any CPI. The market indices have no predictive power since they define the contemporary market movements. We use them only for facultative studies.
Thus, each pricing model should include the price driver and the dynamic reference. A company can be a price taker or price setter. Then, the company share should follow the changes in prices of goods and services related to the company or vice versa. Time delays are possible between action and reaction - some time is needed for any price changes to pass through. In our model, the defining CPIs may lead the modeled price or lag behind by a few months.
JPMorgan Chase was included in our study of bankruptcy cases in the USA. In March and November 2012, we presented an updated model based on the CPI of food (F) and owner’s equivalent rent of residence (ORPR):
JPM(t) = -1.99F(t-3) + 1.15ORPR(t-2) + 6.81(t-1990) + 39.30, February 2012
JPM(t) = -1.86F(t-4) + 0.99ORPR(t-2) + 7.04(t-2000) + 116.91, October 2012 (1)
In December 2012, we published a paper comparing the evolution of JPM stock to four financial companies. Here we update the model using new data between December 2012 and March 2014. The 2012 model has slightly changed: the index of food is replaced by the index of food away from home (SEFV) and ORPR is replaced by the index of rent of primary residence (RPR):
JPM(t) = -5.02SEFV(t-0) +2.46RPR(t-3) + 17.89(t-2000) + 373.10, February 2014 (2)
Figure 1 depicts the overall evolution of both involved consumer price indices: SEVF and RPR (the previous CPIs, F and ORPR, also shown). In March 2014, we revised the JPM and GS comparison and found that they are still similar in stock price evolution.
One can guess that the changes in the RPR index can directly influence JPMorgan Chase through house prices and mortgages. Then, the SEFV index should provide a dynamic reference. To illustrate the overall market evolution we use the S&P 500 index. Figure 2 displays the evolution of dSEFV (the first difference of SEFV) and dSP500, both normalized to their respective absolute maximums between July 2003 and March 2014. The similarity between the dSEFV/dSEFVmax and dSP500/dSP500max (term 0.37 is needed to equalize the peaks) is best visible in 12-month moving averages. In that sense, the SEFV index is able to represent major market movements in statistical terms. There is no other interpretation of this reference CPI except the statistical one.
According to (2), the predicted curve in Figure 3 is contemporary to the observed one. The residual error is of $3.28 for the period between July 2003 and March 2014. The price of a JPM share is relatively well defined by the behaviour of the two defining CPI components. Figure 3 also depicts the high and low monthly prices for the same period, which illustrate the intermonth variation of the share price. These prices might be considered as natural limits of the monthly price uncertainty associated with the quantitative model. Figure 4 displays the residual error.
The model cannot predict the future of JPM price from the defining CPIs. However, there are some medium-term trends in the defining CPIs. Figure 5 depicts the dRPR and dSEFV curves together with their 12-month moving averages. The rate of dSEFV growth decreases (together with the S&P 500 return) and its influence on JPM price is getting smaller. In case the growth in dRPR extends into 2014 the price of JPM will be growing along the same linear trend. For Goldman Sachs, we have found a larger growth potential.
Figure 1. Comparison of SEFV/RPR and F/ORPR.
Figure 2. First differences dSEFV and dSP500 normalized to their respective absolute maximum values between July 2003 and February 2014. 12-month moving averages of these differences are similar, i.e. dSEFV is a good approximation of dSP500 at a medium-term horizon.
Figure 3. Observed and predicted JPM share prices.
Figure 4. Model residuals, standard error of the model $3.28.
Figure 5. First differences of monthly estimates: dSEFV and dRPR. Moving averages of these differences show their medium-term trends.