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An Effort for a Rational Valuation of Today’s Indices / Marketplace

My focus is “Investing Wisely”, e.g. taking advantage of the Bull / Bear Cycles as they occur within the overall marketplace. Integrating modern analytics within these Cycles, means maintaining a process of the thorough fundamental analysis of the marketplace as represented by Indices such as the S&P 500, 400, and 600 Indexes, etc. This often begins with the old top/down research of these and several other Indices. I believe that this discipline provides the necessary clarity regarding the Rotation that most all Companies goes through - from favorable times to unfavorable times and perhaps back again.

“The Market is doing what it Loves to Do”! That statement is very true, and it does as it wishes both fundamentally and technically. However, what often appears to be a Fact is, in reality, quite definitely - very creative Fiction. The fictional stories being told by Wall Street and the media are so compelling that the public Investor takes the hook, every time! That’s sad.

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Since coming out of retirement in October 2007, and re-entering the realm of earnings analytics, I have witnessed a vast change in “Valuation” practices. Oh, the shenanigans and other games were going on before, but it has developed into a finely honed science. Many of those who are supposed to be analysts are providing future estimated operating earnings, as if they are really actual values today. They definitely are NOT and this has bothered me greatly. The marketplace clearly “wants to be told -- all is ok” so that is what is being given. That is at the expense of a lost word in our present financial reporting - it is called “Integrity”.

In the recent weeks of “earnings season”, the arguments are even more compelling and the numbers even more unrealistic. Statements are being made that “stocks are cheaper” than in February 2009”. That is the ratio of the S&P 500 to the current forward operating earnings' estimate. Analysts have clearly created new methods for calculating valuations, just as if, we were currently at historic lows going back to 10 or even 20 years ago. Impossible but true! I suggest that you start taking account of these practices and understand that much of this “new / funny math” is almost worthless data. This is not sound valuation work and little more than random guessing.

So for me and perhaps for you, the question is: Can there still be a way that forward operating earnings (NYSE:FOE) be employed as a useful measure of market valuation? The answer is actually and remarkable - Yes. The data is still there and the formulas of old fashioned “real math” still work. However, if “they” are going to be “Creative” so will I, in a much different manner. I have recently used the word “tweaking” the numbers in my Articles. What I mean is adjusting valuations back to reality.

This can be done with the help of studying price movement and regression analysis, which is not necessarily what I would call "technical analysis". Through comparative analytics the price movement can be accurately correlated with future estimated operating earnings. As an old guy, with a bit of fox still left in me, I find this to be fun and has produced some very accurate forecasting.

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I suggest that the below Chart is well worth your time for a brief study. It should at least cause the Bulls to pause, for a minute or two.

click to enlarge

Notes for Chart.

Saying it nicely, revisions to analyst earnings projections only require a little more work/analytics to get it right. Once completed you have one of the best Leading Indicators to provide a path to Inflections Points for the General Stock Market, Sectors, Industry Groups, and their component Companies.

You will note in this chart that the 12-month forward S&P 500 earnings estimates peaked at $103.61 per share right when the market peaked in October 2007. It bottomed, in March 2009 at $60.08.

The consensus analyst earnings estimates on a 12-month forward basis peaked this year in April, again in phase with the S&P 500 at $94.79. It has since declined for five months in a row and so far in September is down 1.3%, to $86.74.

So you may say that it missed the September rally, and you would be right. Except, for “new/funny math”. Think about that . . .

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My Current Market Valuation:

The Market’s Indices remains over-extended, hyper and ready to disappoint. There is an Internal consolidation of future earnings that is not a precise indicator. However, it is an excellent leading (anticipatory) indicator. The current “choppy” topping process of the Indices themselves is characteristic with past examples. Those examples are ancient history except for this past April. This past April the Indices took over six weeks to top.

The concern that should be on your mind and is definitely on my mine, is that one or two days of declines can seriously erode profits you may have accumulated over a long time frame. The current market environment is one of very real “Caution”.

Mathematically, the Fair Value of the S&P 500 Index depends on the return that Investors require, the current earnings level, the expected growth in earnings, and the probable P/E ratio, that it can be expected to be sold for, at the end of a reasonable holding period.

That said,

I believe that the fair value for the S&P 500 is currently about 1125. I use this number as a “mean” with positive and negative regression points. If then my Valuations say that there is an 8% - 10% expected upside return, this takes the upper range (positive regression) to about 1230 – 1250. Low range (negative regression) might be about 6% - 7% or about 1030 - 1040. So my Valuation estimates (Regressions) are in place and require only occasional adjustments.

My current forecast (adjustments) for the upper range of the S&P 500 is less than the above 1230 – 1250 and may well be at or around 1200. My current forecast for the lower range of the S&P 500 is also less than the above 1030 – 1040 and may well be less than the June lows of 1022.

The next set of quarterly earnings numbers become available in November.

For an (Up to the Minute) Chart of my favorite 5 Indices:

Click and Scroll Down – here

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID4095527

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My Wrap:

It is important that this Article not be viewed as a recommendation for the purchase or short sale of any Company or ETF at this time. Favorable to the process of “Investing Wisely”, it is intended to suggest that most Indices such as the S&P 500, 400 and 600 Indexes, etc. are just an excellent “bellwether” to help identify Inflection Points as the marketplace cycles from Bull to Bear and back again over and over and over again.

It is this continuous “Cycling” that presents us all with clear Inflections Points.

So the good news is that - we are given frequent and conservative (low risk) opportunities to “Invest Wisely” or to simple hold cash.

Source & Data Information: BarCharts, Bauer Capital Management, Bloomberg, CNN Money, Fortune, Harver, MSN Financial, Seeking Alpha, StockCharts, Reuters, Yahoo Financial, Worden.

Disclosure: No Positions

Source: An Effort for a Rational Valuation of Today’s Market