AllMarket Outlook
logoArgusSeptember 15, 2020

Daily Spotlight: Stocks Have Pulled Away from Fair Value

Market Outlook
- term

Stock prices, as expressed by the S&P 500, have dropped recently from all-time highs -- but remain above fair value, which our model pegs at closer to 3000 due to an expected earnings decline in 2020. Our stock-market valuation model takes into account factors such as stock prices, five-year normalized earnings (three historical years, two forward-looking), GDP, inflation, and T-bond and T-bill yields. We note that stocks rarely trade right at fair value. Since 1960, on average, the index has traded at a tight 0.2% above fair value, but the standard deviation to the mean is 17%. As such, we normally expect the S&P 500 to trade between 17% undervalued and 17% overvalued. At current prices, the stock market is almost exactly 17% above fair value, implying that investors are quite optimistic about equities in the coming months. We'd feel better about the outlook for stocks if valuations were not so stretched. Several factors could improve valuations: a further pullback in stock prices, lower bond yields, or better earnings all could do the trick. Still, given the current fully valued level of the market, disappointments could be painful.

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