As a big picture stock strategist, I grapple with one question more than any other. How do I determine what method works best to come up with a current fair value on the S&P 500? This is always the biggest question on investor's minds.
In your eyes, is this stock market fairly valued?
We have enjoyed a huge run-up in share prices the last few years. Is this party over because the value of stocks got too high? That is the wall of worry the market has been climbing the last few weeks. If the S&P 500 index comes to a point where investors say PRICES ARE TOO HIGH, stocks stall.
My sense of what accurately reflects ‘fair value’ is guided by the following four “back-of-the-envelope” methods to determine that ‘fair value’.
Read on to understand where I am coming from…
Recall that the Global High in Q3-2007 was 1565 for the S&P 500.
(1) Size Stock Price Fundamentals to the Nominal Growth of the U.S. Economy
Current Dollar U.S. GDP in Q3-2007 14.57 $US Trillion
Current Dollar U.S. GDP in Q3-2013 16.85 $US Trillion
+15.7% Change in Current Dollar GDP over the last six years.
§ 1810 is fair value for the S&P 500 right now.
(2) Use a Proxy: Two Percent Real GDP Change Over Six Years.
§ 1762 is fair value for the S&P 500 right now.
(3) Look Forward on 2014 Bottoms-Up S&P 500 Earnings.
Apply a 15 Forward Price/Earnings ratio to:
$121.9 dollars per share for S&P 500
§ 1828 is fair value for the S&P 500 right now.
(4) Look Forward on 2014 Top-Down S&P 500 Earnings.
Apply a 15 Forward Price/Earnings Ratio to:
$118.2 dollars per share for S&P 500
§ 1773 is fair value for the S&P 500 right now.
My Real Time Insight (RTI) questions:
(1) What method (shown above) works best for determining fair value on the S&P 500 stock index?
(2) In light of your answer, is this stock market fairly valued?
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