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S&P 500 Fair Value

S&P 500 Index

I wrote to our clients with their September 30th Quarter-end statements that I was getting uncomfortable with the market and how high it had gotten. At the time, and it continues, I was worried about the potential earnings from companies not living up to expectations.

So far, earnings season has been pretty difficult. Many of the large S&P exporters have been hurt with revenues below estimates for the quarter due to the high level of the dollar.

We had been raising cash going into earnings season as a precaution against any sort of correction due to expectations not being met.

Now that we are well into earnings season, I wanted to calculate for you what a reasonable assessment of the Fair Value of the S&P 500 might be:

Fair Value Range

In the chart above, you can see that I have calculated a low-end and high-end range based upon several factors of the S&P 500: the historic compound annual growth rate, the earnings growth rate, actual trailing 12 month earnings, projected future 12 month earnings, and a discount rate.

I then used those calculations as inputs to a Future Earnings Discount Model to derive a fair value range of 1302 to 1455 on the S&P 500. The low-end of the range represents a 9% downside and the high-end of the range represents a 2% upside to current levels on the S&P 500.

This is a dynamic model with the inputs changing constantly, but it gives me quantifiable method for determining when the market is getting ahead of itself and when it is lagging its fundamentals.

The fair value numbers are only as good as their inputs, and with the earnings from the multinationals coming in below estimates, I am seeing the top-end come down on a daily basis right now.

Given that I have been in the business for nearly 30 years, I get gut feelings on certain things just by watching the flows of money into and out of the market as well as how the markets act vis-a-vis their trend. So I like to do a gut-check against this quantifiable model at times like this just to make sure the numbers are paralleling my observations.

The market has risen significantly, and we are very close to the top of the secular bear market trading range discussed a couple days ago on the blog. So, it is not surprising that we are seeing some pullback.

I’ll be back on the blog with more as earnings season unfolds, but I wanted you to get a feeling for where we were from a valuation point-of-view relative to the news coming out of earnings season.