Monday, October 8, 2012

Q3 GDP Estimate & Our 12-Month Target for S&P 500

We thought to provide our initial estimate of annualized real GDP growth for Q3.  We currently project a GDP growth rate of 1.4%, below the 1.6% consensus, but slightly higher than Q2's 1.3%.  We note that the annualized and seasonally adjusted growth rate of Alcoa's (AA) revenues is one of the factors used in our model.  Our Q3 AA revenue assumption is based on the Street's $5.57bil estimate.  AA's results, which will be released tomorrow after the close, may force us to adjust our estimate.  While AA is no longer a bellwether for the equity market (as the market is no longer based on fundamentals), we believe its top-line does provide some color on current and future domestic and global economic growth. 
From a slightly more fundamental standpoint, we looked at the latest S&P 500 EPS estimate for CY '13.  Given the modest economic growth (without much acceleration expected during the next couple of years) we thought that trading at approx. 12.5x 2013 EPS, S&P 500 may be slightly overvalued.  To get a better idea, we got our hands on the experts' average annual growth rate of earnings for the next five years.  According to S&P, that figure currently stands at 10.83%.  We thought that given the current macro environment, a PEG of 1.0 might be appropriate for valuing the S&P 500.  Applying a P/E of 10.83 to the CY '13 EPS estimates gets us an S&P 500 target or valuation of 1247, approx. 14% less than where it closed at today. 
Although fundamentals are no longer driving the market as much as they used to or as much as they should, in our opinion, they do provide a better, or more realistic perspective on valuation, which will come in handy in the future.

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