Fair Value for the S&P 500? Tell Me Lies, Sweet Little Lies 38 comments
an article to
-
Font Size:
-
Print
- TweetThis
The summer rumbles on with the risk-on orgy intact. After a brief wobble earlier in the day Monday, the S&P 500 closed on its highs for the year, and a welter of bullish strategists send missives with 4-digit price targets and dreams of a sustained V-shaped recovery.
Now, Macro Man is surfing the risk-on wave, especially after jettisoning the non-performing player yesterday who had harshed his smooth since late last week. In the short run, a steady flow of funds into equities and other risky assets will drive prices higher, assuming such flow materializes.
The problem that some so-called perma-bears have is recognizing the temporary importance of such asset flow, and how far it can push asset prices. By the same token, the problem that some of the flow-of-funds, risk-on crowd have is failing to recognize that buying something just because other people do is nothing more than an exercise in the 'greater fool' theory. And while the market may well be a voting machine in the short run, as Benjamin Graham observed it is a weighing machine in the long run.
Macro Man was debating the long-run outlook for stocks with an FX-only punter yesterday who asked him what he thought "fair value" was. This raises one of the critical issues that a macro punter like your author has with equity markets. It's gotten to the point that the stock market is so rife with misrepresentation and lies that it's very, very difficult to get a firm idea of what's priced in.
Now highlighting the fact that the stock market is full of misrepresentation is hardly breaking new ground, even for this space. But Macro Man does wonder... when Barry and Gordon take a break from fingering your wallet to try and build a better (financial) mousetrap, why they don't do anything to address the web of lies, sweet little lies, that surface every reporting season.
Misrepresentation in corporate earnings statements is rife; according to S&P, of the 197 S&P 500 companies to report this quarter, only a quarter have actually earned the number reported in the headlines. Fully 63.5% stuffed "one-off" or "extraordinary" items in their income statements, while only 24 of the 197 had reported earnings that were higher than headline operating earnings. Interestingly, some of the latter were quite sizable, courtesy of some of the worst performers of the whole crisis: Z-list financials, Ford (F), etc. The dispersion graph is shown below:
click to enlarge
So in valuing equities moving forward, what concept of earnings should we use? Pick a number, any number. Looking at 2010 earnings estimates yield an incredibly broad range of forecasts. If you believe the crack-smoking bottom-up guys who strip out everything that could be construed as a "loss", you get a resounding $74 per share. Not bad!
Taking the same approach (stripping out the quarterly "one-offs"), but from a top-down framework, yields a substantially less rosy result: earnings of just $46 per share. And actually counting all the turds for what they are on a top-down basis yields 2010 EPS of just $37 per share.
Source: S&P
Remarkable! On this basis, equities are either pretty darn cheap, or bum-clenchingly expensive based on 2010 earnings. Gee, thanks. Now obviously, trusting analysts' forecasts is a treacherous endeavour at the best of times, but it's small wonder that you have some people screaming "buy buy buy buy buy!!!!" whole others mutter "you guys are frickin' morons" under their breath (or not, as the case may be.)
The chart below shows the appropriate valuation for the SPX based on a) the 3 sets of earnings estimates listed above and b) a range of multiples, none of which is completely unbelievable.
This little exercise yields a range of values for the SPX from 300 to 1480. So regardless of where you fit on the bull/bear continuum, there's probably a forecast here that fits your view. (Macro Man cannot help but observe, however, that all of the top-down valuations are well below current levels.) It's also a pretty good indication that if someone tells you that they "know" what fair value is for the SPX or equities generally, they're almost certainly lying.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
Top
StockTalkers.-
1
David Fry
-
2
Cliff Wachtel
-
3
Mike Havrilla
-
4
David White
-
5
Hedged In
Top StockTalkers » -
1
On Jul 28 05:29 PM Davewmart wrote:
> No investment advice here. The market is so manipulated that small
> investors are likely to be badly stuffed anyway, whilst the profits
> are creamed off.
> The aim should be to loose less than the other guy at the moment,
> not to make money.
> The big unknown is how long the ponzi scheme can continue, as money
> is being printed which is flooding into stocks leading to their current
> valuations.
> Notice that nothing here is being said about absolute levels, so
> that the nominal value of the stock exchange might not go down much
> - stocks will just be trashed on real purchasing power.
> Personally I reckon deflation will triumph for a fairly long time,
> then hyper inflation will bite.
1)Stress tests conducted by our independently-minded government showed that "WITHOUT A DOUBT, BANKS DON'T NEED MORE THAN 75 BILLION." Not one cent more!!!
2)Housing showing signs of stabilizing and will bottom ANY HOUR NOW
3)Obama will create 5 million jobs(speaks for itself)
4)I saw a crowd of people hangind around by California Pizza Kitchen this Sunday that just two months ago WERE NOT THERE!!!
5)#4 shows that the consumer is showing confidence Ron Jeremy couldn't match-I mean, A WHOLE CROWD!!
6)The government knows what they're doing
7)The stimulus plan's money is making it's way through to poor institutions that unfortunately got caught up in this mess like banks and auto.
8)Market is rallying and we will see DOW 10k by the end of the year.
9)The recession is over- Today 9 guys on TV told me it was (just wish I still had my job, but no one gets everything they want. BUT AT LEAST THE RECESSION IS OVER)
10) Most of the crisis probably never even happened. Don't believe everyone you read or see on TV-trust me on this one.
For one year (2008) panic reigned as the frightened investors threw away their investments. The S&P will go a long way up as the losers continue to lose by not buying stocks (they are quite happy with their 0.5% bank accounts which continue to go nowhere.)
I'm hoping it's sarcasm.
On Jul 28 10:58 PM j-dub wrote:
> Ten reasons not to be short the U.S. stock market
> 1)Stress tests conducted by our independently-minded government showed
> that "WITHOUT A DOUBT, BANKS DON'T NEED MORE THAN 75 BILLION." Not
> one cent more!!!
>
> 2)Housing showing signs of stabilizing and will bottom ANY HOUR NOW
>
>
> 3)Obama will create 5 million jobs(speaks for itself)
>
> 4)I saw a crowd of people hangind around by California Pizza Kitchen
> this Sunday that just two months ago WERE NOT THERE!!!
>
> 5)#4 shows that the consumer is showing confidence Ron Jeremy couldn't
> match-I mean, A WHOLE CROWD!!
>
> 6)The government knows what they're doing
>
> 7)The stimulus plan's money is making it's way through to poor institutions
> that unfortunately got caught up in this mess like banks and auto.
>
>
> 8)Market is rallying and we will see DOW 10k by the end of the year.
>
>
> 9)The recession is over- Today 9 guys on TV told me it was (just
> wish I still had my job, but no one gets everything they want. BUT
> AT LEAST THE RECESSION IS OVER)
>
> 10) Most of the crisis probably never even happened. Don't believe
> everyone you read or see on TV-trust me on this one.
Woo-Hoo!
Happy days are here again!
Valuations are at historic lows (just like mortgage rates and home prices). It's time to buy, buy, buy!
By the way, "I'm going door to door to tell you about my exciting new economic recovery!"
Oy vey....
If they fudge ratings and bank solvency's do you really think that the accounting and reporting on fair value for the S & P 500 is valid?
Thanks for the good article.
Therefore you need to understand the business you are investing in or invest in the Index of your choice because you are optimistic that the largest economy in the world is going to make progress that will overcome the corruption in the long term.
A great article but the conclusion should be that "fair value" should be based on historical data. That means we use reported earnings to apply the historical range of P/E ratios. Given that Standard & Poor's predicts a P/E of 26 at an S&P 500 level of 919 at the end of 2010, I would say that we are easily way above fair value. Only if you believe we can expect high growth in the coming months and years can you provide any sensible, fact-based arguement and even then then it is hard to argue that the stock market is undervalued.
The market will do what it's going to do in the short run but in the long run it will revert to a reasonable level of valuation and that is much, much lower than where it is at currently.
See S&P's data for yourself:
www2.standardandpoors....
> Macro man has been wrong for 5 months. He seems to be setting a record
> for being wrong the longest.
>
> For one year (2008) panic reigned as the frightened investors threw
> away their investments. The S&P will go a long way up as the
> losers continue to lose by not buying stocks (they are quite happy
> with their 0.5% bank accounts which continue to go nowhere.)
This is prime example of why one should not involve their ego when investing. CLH has ignored the fact that the market is still down about 40% from its highs in 2007 and by any measure is in the throes of a bear market. Many wise people did see the bounce from the lows in March and profited and are now out, waiting on the sidelines, a perfectly reasonable and prudent startegy, imo.
I have taken losses believing that the market had topped but with a good strategy those losses have been limited and I will be in position when the market has head faked enough people and really makes its move. If I am wrong I may even end up back where I started in 2007...a reasonable position, as far as I'm concerned.
Given the historical data on valuation and current economic climate there is almost no chance the market will continue higher past a point of simply filling the gap left from the crash of October 2008.
On Jul 29 08:54 AM CLH wrote:
> Macro man has been wrong for 5 months. He seems to be setting a record
> for being wrong the longest.
>
> For one year (2008) panic reigned as the frightened investors threw
> away their investments. The S&P will go a long way up as the
> losers continue to lose by not buying stocks (they are quite happy
> with their 0.5% bank accounts which continue to go nowhere.)
Combine that with low long-term interest rates and you find a rather large risk premium currently built into stocks (i.e. they are undervalued). Who knows where stocks go over the next 6 months or a year, but over the next ten years, we may have the best returns (10-yr returns) since the early 90's.
My fair-value model puts the S&P around 1250. Even if 10-yr bonds rise to 6%, I think equities are currently worth 1125.
Financial analysts are ALMOST NEVER neutral to the stocks they are analyzing. If you have a trunk full of CAT shares and want to get rid of them in a Bear Market, what do you do. You get together with all your friends (other analysts from other companies) and you all mark up expected losses thorugh the roof -- then, when CAT reports earnings, and the financial press goes ape about "CAT beat the street estimates", and when the stocks rises, you sell into the rally. Isn't that how it works?
the reason that morningstar gives unbiased but sometimes unright valuation estimates is that they are not privy to all the inside information that corporate upper management & directors have. it pays to look at who is buying or selling what, and when and why.
> jack
www.fxstreet.com/funda...