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Signs the Stock Market has reached Fair Value

On multiple fronts, equities appear to have incorporated the bad news and are undervalued both absolutely and relative to fixed income:

  1. The risk premium, the market's earnings yield less the risk-free rate of return, is substantially above the long-term average reading.
  2. Using reasonably conservative assumptions (most importantly, a near 50% peak-to-trough earnings decline, which is over 3x the drop in an average recession), the market has discounted 2009 S&P 500 earnings of about $47.
  3. Valuations are low vis-à-vis a decelerating (and near zero) rate of inflation. Indeed, the current market multiple is consistent with a 6% rate of inflation.
  4. Stock prices as a percentage of replacement book value stand at 1x, well below the 1.4x long-term average.
  5. The market capitalization of U.S. stocks vs. stated GDP has dropped dramatically, to about 80%, now at the long-term average. Warren Buffett was recently interviewed in Fortune Magazine and observed that this ratio was evidence that stocks have become attractive.
  6. The 10-year rolling annualized return of the S&P is at its lowest level in nearly 75 years, having recently broken below the levels achieved in the late 1930s and mid 1970s.
  7. A record percentage of companies have dividend yields that are greater than the yield on the 10-year U.S. note. At 46% of the companies, that is over 4x higher than in 2002 and compares against only 5% on average over the last 30 years.

I didn't write this, but these are the same points that I've been following. Doug Kass, famed investor and CNBC guest commentator wrote, this and I appreciated how concise it was and how it covered the relevant points.

Does that mean we have bottomed? Can't say for sure, but we are certainly closer to a bottom than we have been. Markets bottom when we have the most negativity and people believing that everything is headed to zero. With the news filled with unbridled negativity (a negativity bubble, even) but so much monetary stimulus in the system, just a spark to get things moving will cause the stock market to run up to the 200 – day moving average.

Previously I wrote that I thought we run up to the 200-day moving average on the S&P 500 prior to end of April, fall back down during the summer, then recover to roughly break-even on the year. I still believe that is possible, but we'd need to get moving soon or mathematically that just won't be possible.

Mark