Top-down Valuation of S&P 500 as of 8/1/2009
Valuation (top-down): fair-to-overvalued
- Our framework for market outlook is first and foremost concerned with valuation. We say the market is “fairly valued” if our analysis suggests an expected return for a buy-and-hold investor of between 8-12% per annum. If the expected return is less than 8%, than we would say the market is overvalued (expensive). If it is more than 12%, than we would say that equity markets are undervalued (cheap). In our top-down analysis, we estimate a return expectation by applying a fair PE (12-17x) to forward EPS expectations and discounting back to today’s index price. The target range of 12-17 x EPS is derived from underlying assumptions about conversion of EPS to Free Cash Flow and long-term EPS growth. At present our expectation is for about a 8.7% total return on the S&P (see analysis below). While this is within our range of acceptability, its certainly bordering on overvalued. For example, you could position yourself higher up the capital structure and get an 8.7% yield with a portfolio comprised of 60% high quality corporate bonds (LQD, yield 6%) and 40% high-yield bonds (JNK, yield 13%). Our “buy below” price on the S&P 500 right now, for an expected return of 12% or more, is 946.
_____________________________________________________________________________
Disclaimer: This information is presented for general purposes only and should not be construed as being the primary basis for an investment decision, or as reflecting recommendations taking into account your individualized requirements. As always, consult your financial advisor before making any decision based on this or any other information. (full disclaimer)
