Tag Archives: crisis

The Perfect Storm Is Here: Managing Your Wealth Will Be The Hardest Thing You’ve Never Done

Summary Today’s wealthy investors and Wall Street have always had it so good. With credit expansionary schemes near exhaustion, what is the next bubble to bust? The next great financial crisis has already begun and the global currency war is your first clue. A traditional portfolio asset allocation won’t necessarily help your wealth survive what’s ahead. “What we learn from history is that people don’t learn from history.” Warren Buffett said it best. We are now late in 2015 and approaching the 8-year marker since the onset of the Great Recession of 2008. In a cyclical world of boom-to-bust economic and market history, we find the global financial markets of the developed world economies (ex-China) are all still trading near record highs. Private equity and pre-public venture capital valuations are fully valued across most historical metrics, and both commercial and residential real estate are also priced near the higher end of their historical valuation and price range. The Great Recession of 2008-9 is long forgotten by most investors and the Internet Bust of 2001-2 is now ancient history. Further back, the Bond Market Bust of 1994, the Stock Market Crash of 1987, and the Great Stagflationary Recession of early 1980s are buried within the digital archives of Wikipedia. Although our 7-year boom-to bust cycles are quickly dismissed from our collective investor memory banks, they have been quietly building in their financial intensity and devastating effects on our wealth. Thanks To A Lifetime Of Credit Expansionary Policies And ‘Easier Money’, The Wealthy And Wall Street Have Always Had It So Good For nearly 35 years, US monetary and fiscal policies have been the greatest ally to investors looking to build significant wealth and stay ‘long risk’ through the years. The buy & hold mentality is still deeply ingrained into both institutional and individual investor DNA. Through financial crises, bear markets and economic recessions, investors have been rewarded by not panicking and simply holding on. After all, the Federal Reserve and central banks had your back. Since 1980, through most investors’ professional lifetimes, the secular decline in interest rates tells the story of how this relatively complacent behavior of today’s investor psyche was born. (click to enlarge) To be sure, this has not only been a US interest rate phenomenon, but a global story among the world’s developed economies too. In fact, for the first time in history, short term government bond yield curves are now negative in both Germany and France, and near negative in the U.S. and Japan as well. (click to enlarge) The bad news for the global economy, however, is that record low interest rates have been excruciatingly painful for retirees, income investors, and the ‘savers’ class in general. Millions of people have watched their annual retirement income stream cut by nearly 2/3rds in just the last few years. Worse yet, there is also a huge problem looming for global public sector and private sector pensions that are growing increasingly underfunded with perpetual low rates destroying their ability to meet longer-term liabilities. Sovereign nations, cities, states, and municipalities will be unable to meet their unfunded liability obligations putting even more pressure on an aging world population and government safety-net programs. That said, long-term interest rates won’t stay low forever, particularly given how late we are in the current global economic cycle. If only human nature would let our minds look out just a bit further than our noses. (click to enlarge) Beyond decades of accommodating monetary policies, global fiscal policies have also been exceedingly generous to the wealthy. Endless government deficit spending and bailout programs have reached unprecedented and unsustainable levels. Skyrocketing debt-to-GDP ratios with no political consensus in Washington and around the world has fiscal credit limits near exhaustion. We will soon approach an inconceivable $10 Trillion of additional government debt load in the US alone since the onset of the Great Recession of 2008. (click to enlarge) To put this recent $10 Trillion government deficit spending binge into perspective, it took the United States 231 years to accumulate the first $9 Trillion of government debt and only 9 years to more than double it. With Credit Expansionary Schemes Near Exhaustion, What Is The Next Great Bubble To Bust? When the risk-free lending rate is near 0% (free money), one could argue that everything and every asset is being mispriced in one way or another. That’s right, everything. According to the Austrian Economic business cycle theory, free money also creates an investment environment that encourages dangerous ‘malinvestment’. Malinvestment can best easily be understood as essentially ‘bad money chasing good money’ into mispriced and often overpriced assets based on misleading price signals and a low lending rate. We now know the Dotcom Bubble of the 1990s and Housing Bubble of the 2000s were classic periods of ‘private sector’ malinvestment – whereby the laws for Supply & Demand clearly defied any logic. Until they went bust. History is cluttered with ‘public sector’ malinvestment periods too, whereby government bonds and risk-free assets themselves became the overpriced asset bubble. What transpired during those historic economic periods was a combination of government bond defaults and restructurings – with rising interest rates and high inflation across the globe. High inflation attributable to significant credit quality deterioration in the underlying sovereign debt issuer (bad inflation) as opposed to the higher inflation of a growing and prosperous global economic environment (good inflation). Today’s investors have long forgotten the long history of government bond default crises both here and abroad. (click to enlarge) Fast forward to the Global Government Bond Bubble here in the 2010s – whereby in just the last 7 years, the massive bond market ‘supply’ has grown at an exponential rate over the slowing global economy’s financial ability to service and support it. Global bonds, by any historical measurement, are screaming ‘global recession’ at best, or ‘global depression’ at worse. On the other hand, global stocks, ex-China, are screaming that growth prospects looking ahead are strong, asset inflation is rising and market ‘risks’ are minimal. Which market is now telling us the truth about the global economy – is it the world’s bond markets ( record deflation ) or the world’s stock markets ( record asset inflation )? The answer is that neither market is telling us the truth – as the world’s central banks have now suspended the free market’s price discovery mechanism of both markets through the monetization of the world’s debt markets (also known as quantitative easing, money printing, or ‘Ponzi’ economics). The big buyers of last resort are the global central banks with their perpetual backstopping of bond markets and free money policies. As a result, the world’s stock markets have gotten a free pass too. (click to enlarge) By extending zero interest rate policies (ZIRP) for 7 years and running, the world’s central banks have attempted to orchestrate an ‘indirect’ stimulus program of their own, forcing savers and fixed income investors out of cash and/or cash equivalents and into the riskier dividend stocks and equity markets. Creating a ‘wealth effect’ among businesses and consumers can be beneficial in the short run, as it was in the Internet Bust of 2001-2 and the Great Recession of 2008-9. At the same time, central banks have conveniently, and quietly, kept the cost of funds for many of the overextended, nearly insolvent developed nations at artificially ‘low-to-no’ interest rate borrowing levels. Many nations on the brink of sovereign default now require a perpetual ultra low cost of borrowing in order to maintain solvency. In the end, financial markets trade on perception as much as reality, and market perception that a perpetual central banking ‘put’ (a bid) on financial assets has greatly contributed to our multi-year bull market in stocks, bonds, real estate and risk assets in general. The Next Great Financial Crisis Has Already Begun And The Global Currency War Is Your First Clue “There is no means of avoiding the final collapse of a boom brought about by credit expansion . The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as the final and total collapse of the currency itself .” Ludwig von Mises Founder of Austrian School of Economics (click to enlarge) For 35 years and counting, our global policymakers have done virtually everything in the credit expansionary playbook. Their Keynesian schemes are getting thin with little economic impact, and the free markets are now calling their bluff in the world’s major currency markets. Ludwig von Mises’s forthright plea for ‘voluntary abandonment’ of easy money policies has been repeatedly scorned by the Keynesian economists within the world’s central banks. With most advanced economies’ fiscal ‘credit card’ nearly fully spent up, and with no rational real economy buyers willing to support such lofty bond prices and low interest rates – the dangerous end of an era is precariously close. Nations around the world are aggressively devaluing their currencies in order to make their economies more competitive. There have been a record number of currency devaluations in 2015, with multiple rate cuts in the major economies of the Eurozone, China, India, and South Korea. Despite the rhetoric that US monetary authorities are soon looking to raise interest rates for the first time in over 9 years, a major global currency war is well underway. Welcome To The First Government Debt Crisis In The World’s Core Economy Of The 21st Century (click to enlarge) Global economic growth, particularly across the advanced economies of the U.S., the Eurozone, and Japan has been slowing for the last 20 years despite creating two major ‘private sector’ financial asset bubbles (2000, 2008) whose ultimate ‘bust’ nearly took the world’s economy into a global depression. With global growth now approaching ‘stall speed’, the emerging market ‘BRIC’ nations are now in steep decline for the first time in many decades. China, most notably, as the second largest economy in the world, has witnessed a near 40% crash in its stock market with real economic consequences just beginning to surface. Many market participants are skeptical of the Chinese economy and official economic reporting going forward, with some predicting a severe recession ahead for the country. (click to enlarge) We are entering the first public sector, global government bond bust in the world’s core economy of the 21st Century. The catalyst or series of catalysts to the next investment cycle change can be anything now – from economic, financial, non-financial, political or geopolitical. Arguably, geopolitical risks are now higher than at any point since World War II. We strongly believe the short years ahead will present the most challenging investment period for the great majority of investors in our lifetime. A Traditional Portfolio Asset Allocation Won’t Necessarily Help Your Wealth Survive What’s Ahead “The next crisis could be a very different type of crisis…we’re talking the 1930s where you could have a chain-link of government defaults.” Jeremy Grantham Founder and Chief Investment Strategist of $118B GMO Advisors Managing wealth and advising wealthy clients over our collective lifetime has been relatively simplistic. The primary ‘old school’ mantra can best be summed up by the following common financial advisory cliches: #1 – Diversify your portfolio holdings (stock, bond, cash, real estate) # 2 – Stay the course and don’t panic Pretty easy, right? Truth be told, as simple as #1 and #2 above seem to be, most investors have had trouble over the prior decades and boom & bust markets sticking to this modern day wisdom. After all, human nature and behavior economics have tended to work against the masses. The proof in that statement is the plethora of professional investor services that closely monitor investor sentiment and behavior across time, geography, volatility, and asset classes. The major challenge for global investors going forward is that no investor alive today has ever had to manage wealth through a major public sector debt crisis in the world’s core economy – a crisis that will soon lead to a major secular uptrend in global interest rates as a result of credit quality deterioration (insolvency) in public sector debt including federal, state, local, and municipality paper. Every financial crisis since WWII has been essentially a private sector crisis (industrial, oil, tech stocks, real estate, etc.) or a public sector problem in the peripheral economy (Russia, East Asia, Argentina, etc.). If our deep dive into global economic history and market cycle research proves to be correct, our lifetime of virtuous risk market ‘tailwinds’ are about to turn into vicious risk market ‘headwinds’. According to a recent report from Deutsche Bank, there is an estimated $225 Trillion of total debt in the world today, which is over three times the total world stock market capitalization of $69 Trillion. In the end, the global central banking cartel is powerless to maintain record high debt prices by suppressing low interest rates forever. Investing is simply a confidence game, and sooner or later, investors will lose confidence in the authorities’ futile attempt to control the global economy and free markets. The longstanding risk-free interest rates of our global government debt markets are about to begin rising around the world – likely starting in Europe and onto Japan and Asia, and eventually working its way back to the world’s deepest safe haven U.S. Treasury bond market. Make no mistake, at some point down the road, even the United States of America as the world’s ‘least dirty shirt’ and world’s reserve currency is not immune from major financial market upheaval. As a result, the long-standing ‘old school’ cliches bear two important challenges going forward: #1 – Diversification of assets as opposed to diversification of ‘risk’ will not prevent widespread wealth destruction for most investors. Where will investors hide to protect their wealth when traditional ‘safe haven’ investments are no longer safe? Realized and unrealized losses commensurate to the Great Recession of 2008-9 will likely unfold once again. #2 – Staying the course and ‘waiting out’ the next crisis will likely prove to be a costly approach for most investors. Our global policymakers will not be in a position to execute a quick fix to the economy and your portfolio. Over the last century, there have been multiple periods of extended stock market recovery times in the US lasting from 10 years (1973-1983) to 25 years (1929-1983). In fact, both Japan (1989-today) and Germany (1913-1948) have incurred 26 years (and counting) and 35 years break-even return periods respectively. Again, investor memories are short, and today’s investors have been fortunate to live in a 35-year period of credit expansionary schemes, which has artificially compressed economic recovery times. A Non-Traditional Portfolio Allocation Is Warranted Given The Major Public Sector Financial Crisis Ahead As traditional safe haven investments disappear, investors will look to non-traditional investment opportunities to protect and preserve their wealth and purchasing power. History has provided a road map of how international capital moves through public sector government debt crises. In 2011-2012, for example, European investors experienced first-hand a sovereign debt crisis across southern Europe. Greek government debt, as well as Spain, Portugal, and Italian sovereign paper all sold off dramatically in a very short period of time. Capital flight to other ‘blue chip’ countries including Germany and the US took place in rapid order. Although a short-term fix was put in place by the International Monetary Fund (IMF) and European Central bank (ECB) in 2012, safe haven investors were stunned at the time with huge paper losses in the billions of euros in perceived ‘risk-free’ investments. Investors should intuitively recognize that negative interest rates in Europe, or potentially soon here in the US, are major signals of an impending crisis. Near negative interest rates on long-term Japanese government bonds are further signs of major crisis in the making, particularly as Japan’s fiscal nightmare now widely surpasses Greece’s dangerously high debt-to-GDP and debt-to-revenue solvency ratios. Non-traditional portfolio strategies should consider tail risk and bear market strategies, tangible asset allocations, precious metals, commodities and inversely correlated assets – a combination of both long market and short market strategies – over the years ahead. Major crises never happen ‘all-at-once’, and the coming financial crisis ahead should prove to be no different. Kirk D. Bostrom Chief Portfolio Manager Strategic Preservation Partners LP For more information, please contact Mr. Bostrom and Strategic Preservation Partners LP. Disclaimer: The views expressed are the views of Kirk Bostrom and are subject to change at any time based on market and other conditions. This material is for informational purposes only, and is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. The opinions expressed herein represent the current, good faith views of the author at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented in this article has been developed internally and/or obtained from sources believed to be reliable; however, the author does not guarantee the accuracy, adequacy or completeness of such information.

Myopia & Market Function

Benartzi defines myopic loss aversion as making “investment decisions based on short-term losses in their portfolio, ignoring their long-term investment plan.”. Myopic loss aversion can arise when investors check their account balances or the prices of their holdings which thanks to technology has become increasingly more convenient to do. We know that there will be future bear markets and probably another crisis or two in most of our lifetimes. By Roger Nusbaum AdvisorShares ETF Strategist The Wall Street Journal posted an article written by Shlomo Benartzi who is a professor at UCLA specializing in behavioral finance. The article primarily focuses on the behavioral problems, like myopic loss aversion, that can arise when investors check their account balances or the prices of their holdings which thanks to technology has become increasingly more convenient to do. Benartzi defines myopic loss aversion as making “investment decisions based on short-term losses in their portfolio, ignoring their long-term investment plan.” Benartzi cites that the stock market has a down day 47% of the time, a down month happens 41% of the time, a down year 30% of the time and a down decade 15% of the time. We’ve talked about this before going back before the crisis albeit with some different wording. Before and during the last major decline, as well as many times since then, I’ve said that when the market does take a serious hit that it will then recover to make a new high with the variable being how long it takes. While this seems obvious now it is one of many things frequently forgotten in the heat of a large decline. Additionally we know that there will be future bear markets and probably another crisis or two in most of our lifetimes. And those future bear markets/crises will take stocks down a lot which will then be followed by a new high after some period of time. This is not a predictive comment this is simply how markets work with Japan being a possible stubborn exception that proves the rule. It took the S&P 500 five and half years to make a new nominal high after the “worst crisis since the great depression.” If you are one to use some sort of defensive strategy, it is hopefully one that you laid out when the market and your emotions were calm and your strategy probably doesn’t involve selling after a large decline. My preference is to start reducing exposure slowly as the market starts to show signs of rolling over. Very importantly though is that if you somehow miss the opportunity to reduce exposure, time will bail you out….probably. I say probably based on when a bear market starts in relation to when retirement is started. If a year after retiring, a 60% weighting to equities that cuts in half combined with a life event at the same time that requires a relatively large withdrawal (this is not uncommon) it will pose some serious obstacles. I think the best way to mitigate this is, as mentioned, a clearly laid out defensive strategy but not everyone will want to take on that level of engagement. In that case it may make sense for someone very close to retirement and having reached their number (or at least gotten close) to reduce their equity exposure. Not eliminate, but reduce. Back to the idea of myopic loss aversion and how to at least partially mitigate it. Knowing how markets work and then being able to remember how they work will hopefully provide an opportunity to prevent emotion from creeping in to process and giving in exactly as Benartzi describes.

Ameren Offers Utilities Investors With Protection From Higher Interest Rates

Summary Midwestern electric and natural gas utility Ameren has seen its share price perform well YTD, with even a disappointing Q2 earnings report proving to be just a speed bump. Following years of underperformance compared to the peer average, Ameren is changing its focus so as to take advantage of demand for new transmission infrastructure. Its Illinois operations will provide it with a buffer against higher interest rates due to that state’s regulatory linkage between allowed return on equity and interest rates. While Ameren’s shares are overvalued on a forward basis, a warm winter in its service area due to El Nino could create an attractive long investment opportunity. Shares of Midwest electric and natural gas utility Ameren (NYSE: AEE ) have rebounded strongly since setting a 12-month low at the end of June, with a disappointing Q2 earnings report only providing a slight bump on the way to an 18% price increase since then. The company has not been one of the sector’s better performers in recent years as weather volatility and arbitrary regulator behavior have held it back. Its regulatory outlook has improved this year, however, in a way that will reduce its exposure to higher future interest rates. Adverse weather conditions in Q4 will provide short-term headwinds first, however. This article evaluates Ameren as a potential long investment opportunity in the context of this operating environment. Ameren at a glance Headquartered in St. Louis, MO, Ameren is a relatively large electric and natural gas utility with more than $20 billion in total assets and a market capitalization of $10.7 billion. The company operates in a 64,000 square mile service area that includes much of eastern Missouri and most of Illinois, excluding Chicago and its surrounding environs. Its operations are divided into 3 segments. Ameren Missouri oversees electric generation, transmission, and distribution plus natural gas distribution in that state’s share of the service area. It currently has 1.2 million electric customers and 127,000 natural gas customers, with the former receiving electricity generated by the company’s 10,200 MW generating fleet. Unlike many of its peers, Ameren Missouri remains heavily reliant on coal, which comprises 53% of its fuel mix (the balance is split between nuclear, natural gas, and hydro). Unlike its counterpart across the Mississippi River, Ameren Illinois only engages in electric and natural gas distribution activities. It has 1.2 million electric and 813,000 natural gas customers in the state. Much of the electricity that it uses is sourced from Ameren’s generating capacity in Missouri via the third and final segment, Ameren Transmission Company of Illinois, which operates 4,600 circuit miles of 345 kV regional transmission lines. Historically, Ameren Missouri has made the primary contribution to the company’s total rate base, reaching 63% in 2011 compared to 29% from the Illinois operations and 8% from the transmission operations. This has negatively impacted Ameren’s past consolidated earnings due to the lack of a favorable regulatory scheme in Missouri. While the state’s scheme does provide utilities with a fuel cost recapture mechanism that insulates them from the type of fuel price spikes that are not uncommon during Midwest winters, its use of historical test years result in a large amount of regulatory lag. This lag prevents Ameren from recognizing higher rates due to infrastructure investments and similar capex for roughly 2 quarters despite incurring higher depreciation, O&M, and property tax costs during the interim. The regulatory scheme employed in Illinois, on the other hand, has improved in recent years. The most substantial change has been the decision to base the allowed return on equity for electric utilities on the 30-year Treasury rate plus 580 basis points. While this formula currently results in a below-average allowed rate for Ameren Illinois, it will mitigate the impact of higher interest rates following the Federal Reserve’s planned rate hike on Ameren’s consolidated earnings. Furthermore, electric utility rates are based on a year-end rate base and provides for the recovery of “prudently incurred” actual costs, greatly reducing regulatory lag. Illinois natural gas utilities operate within a similar scheme that bases rates on future test years and includes infrastructure riders, similarly reducing lag. Finally, Ameren’s transmission operations are governed by a federal regulatory scheme that reduces regulatory lag by employing forward-looking calculations with an annual reconciliation mechanism. Ameren has reported slow but steady earnings growth since 2013, although its annual EPS results have yet to return to their pre-financial crisis highs. Its annual EBITDA, meanwhile, has remained flat over the same period, highlighting the lack of growth in its service area over the last several years. The company was hit especially hard by the 2008 financial crisis and slashed its dividend in that year. Since then the dividend has only increased by 10%, causing the company to lag significantly behind its peers. Its yield had been much higher than the sector average before the crisis and remained high even after the cut, however, and as a result, it has a forward yield of 3.9% despite this low growth rate. Q2 earnings report Ameren reported Q2 earnings at the end of July that missed the analyst consensus on both lines. It reported revenue of $1.4 billion (see table), down by 1.4% YoY and missing the consensus by $40 million. Revenue from its electric operations increased by 1.2% and provided 89% of consolidated revenue as higher demand in Illinois more than offset reduced demand in Missouri as the latter state experienced a mild early summer. Natural gas revenue fell by 18% YoY due to a 3.2% decline in volumes as Illinois experienced a warmer than normal spring, reducing the number of heating degree days. A sharp fall in energy prices over the previous 12 months also contributed to the lower natural gas revenues in particular. Ameren financials (non-adjusted) Q2 2015 Q1 2015 Q4 2014 Q3 2014 Q2 2014 Revenue ($MM) 1,401.0 1,556.0 1,370.0 1,670.0 1,419.0 Gross income ($MM) 1,049.0 975.0 880.0 1,273.0 1,031.0 Net income ($MM) 141.0 108.0 48.0 293.0 149.0 Diluted EPS ($) 0.58 0.45 0.20 1.20 0.61 EBITDA ($MM) 447.0 459.0 336.0 762.0 522.0 Source: Morningstar (2015). Gross profit rose slightly to $1.05 billion from $1.03 billion YoY despite the revenue decline. The increase was the result of the company’s cost of revenue falling by 9.3% YoY due to lower fuel prices, more than offsetting the negative impact of lower revenues. Operating income fell sharply to $237 million from $322 million in the previous year. While a large loss provision for the construction license of a new nuclear unit was the decline’s major driver, higher O&M and depreciation costs resulting from regulatory lag in Missouri also contributed. Ameren’s consolidated net income fell to $141 million, or a diluted EPS of $0.58, compared to $150 million, or a diluted EPS of $0.62, in the previous year, missing the analyst consensus by $0.03. The most recent result included a $52 million boost resulting from the recognition of a tax benefit via the resolution of an uncertain tax position that the company treated as discontinued operations. EPS from continuing operations came in at only $0.40 versus $0.62 YoY. EBITDA also declined, falling from $522 million YoY to $447 million. Outlook Ameren reaffirmed its FY 2015 EPS guidance range of $2.45-$2.65 during its Q2 earnings call based on the assumption of normal temperatures in Q3 and Q4. The company’s service area did experience more cooling degree days than average in Q3, reinforcing this range. El Nino can be expected to impact its Q4 earnings, however, by bringing warmer than normal temperatures into the company’s service area between October and January. This year’s event is expected to be one of the strongest on record and previous such events have introduced warm weather in Missouri and Illinois during the quarter, reducing demand for natural gas. Ameren is unlikely to be as exposed to El Nino’s adverse weather impacts as many of its peers since the bulk of annual consolidated earnings have traditionally been brought in via its electric operations during the Q2 and Q3 summer months. Furthermore, temperatures in its service area have historically returned to normal by February during past El Nino events. Investors can expect its Q4 earnings to be lower than normal, however. Ameren’s earnings in FY 2016 and beyond will be driven by the company’s ability to utilize its planned capex in a manner that takes advantage of its regulatory environment where possible. The company expects capex to drive a rate base CAGR of 6% through FY 2019 as it invests in a combination of reliability, environmental, and new capacity projects. The latter will be the most important as they are designed to increase the share of its total rate base attributable to its transmission segment from 8% currently to 19% by FY 2019. The transmission segment will achieve a rate base CAGR of 27% over the same period, ultimately reaching $2.3 billion in total capex. The company expects that this will in turn result in an EPS CAGR of 7-10% through at least FY 2018. The company’s ability to achieve and maintain this earnings growth target will ultimately depend on how quickly the Federal Reserve implements its expected interest rate increase. At first glance, Ameren is more exposed than many of its peers to higher interest rates due to its BBB+ credit rating from S&P and Fitch (the credit ratings of its state units are higher). Interest rate spreads have widened in recent weeks as expectations of a Federal Reserve rate increase occurring by the end of the year have grown, with the largest increases occurring for lower-rated debt. At first glance, this would suggest that Ameren will be at a disadvantage to those of its peers with superior ratings. Unlike many of its peers, however, a substantial segment of the company’s operations reside within a regulatory scheme that links the allowed return on equity to interest rates. While this has kept the return on equity below the peer average during the current era of low interest rates, it will support Ameren’s ability to both finance its planned capex and mitigate the negative impact of higher interest costs on its earnings. Looking beyond FY 2016, Ameren’s Missouri operations are likely to be burdened by the U.S. Environmental Protection Agency’s [EPA] recently released Clean Power Plan, which requires individual states to achieve predetermined reductions to the carbon intensities (greenhouse gas emissions per unit of electricity generated) of their respective state utilities beginning in 2022. Illinois has one of the country’s highest carbon intensities and must achieve a 28% reduction by then, while Missouri is not far behind with a required 19% reduction . One advantage of these reductions is that they could pave the way for additional capex to convert existing coal-fired power plants to natural gas and possibly even build new, cleaner capacity. The presence of substantial regulatory lag in Missouri would contribute to earnings volatility. Valuation The consensus analyst estimates for Ameren’s diluted EPS in FY 2015 and FY 2016 have increased modestly over the last 90 days in response to warmer Q3 weather and the Federal Reserve’s decision not to increase interest rates in September, as had been widely expected by the market. The FY 2015 estimate has increased from $2.55 to $2.56 while the FY 2016 estimate has increased from $2.70 to $2.72 over the same period. Based on a share price at the time of writing of $44.10, the company’s shares are trading at a trailing valuation of 18.0x and forward valuations of 17.2x and 16.2x, respectively. The forward ratios in particular are at the high end of their respective 5-year ranges, albeit lower than they were at the end of 2014, suggesting that the company’s shares are modestly overvalued at this time. This is especially true for the company’s short-term outlook given the likelihood of a warm Q4 in its service area. Conclusion Ameren’s shares have exhibited an above-average amount of volatility in 2015 to date as the company has attempted to recover from its past history as a relative laggard in the electric and natural gas utilities sector. Recent developments have mostly been favorable, with its Illinois regulatory scheme changing to link the allowed return on equity to interest rates and the company’s own focus shifting away from Missouri’s poor regulatory environment to its growing transmission operations. This new approach will be necessary if Ameren is to bring its earnings growth closer to the sector average, let alone above it. Fortunately, the combination of new transmission projects, reliability investments, and environmental controls will provide it with large capex opportunities over the next 5 years that will be necessary to support faster earnings growth. Furthermore, its forward dividend yield of 3.9% is relatively high already. The main draw that Ameren has to offer to potential investors is its linkage between allowed return on equity for a substantial segment of its operations and interest rates, as this will offset one of the market’s major current concerns about utilities in general. The company’s shares are also overvalued on a forward basis, leaving them exposed to a substantial decline in the event that this year’s El Nino has a greater than expected negative impact on its Q4 and potentially also Q1 2016 earnings. Yield-seeking investors who wish to be insulated from higher interest rates could view such an event as a potential buying opportunity, however, and I would consider Ameren’s shares to be attractively valued in the event that its forward P/E ratio falls back to 14x its FY 2016 earnings, or $38 per share, as it has already done twice in the last 3 months.