Monday, August 24, 2015

Our latest valuation of S&P 500 (8/24/15) ...

Given the volatility that we have seen the last few days, and the fact that it was about a year ago that we provided our 12-month S&P 500 valuation, we thought to provide an update.

First, as a reminder, on August 7, 2014, we published a 12-month target of 1776 for the S&P 500.  While on the 12th month the index was at 2077.57, we should point out that only 3 weeks after that (today, August 24, 2015), nearly on the 13th month, the S&P 500 closed at 1893.21, only 6.2% above our previous target.  We note that our valuation does not take into account the Fed's intervention in the market.  As mentioned a long time ago, the Fed finds itself in a bind now.  Sooner or later it will have to wipe its hands clean and let the markets operate without its 'very visible hand'. 

S&P 500 12-month target

We glanced over the latest S&P 500 earnings estimates (provided by McGraw Hill's S&P Dow Jones Indices, LLC) and realized that the consensus for CY '15 operating earnings (bottom up) has declined 18% since July of last year!  Yes, a big chunk of such a decline may be due to the big dump that oil has taken, but then again, one would expect such decline to result in significant top-line growth and margin expansion in other sectors.  Unfortunately, unlike what the 'experts' keep pitching, this has not necessarily been the case.  

Believe it or not, even with the latest significant market decline, we now think the S&P 500 can go lower, possibly to 1660 within the next 4 quarters.  The index is currently trading at 16.9x and 14.4x CY '15 and CY '16 operating earnings, respectively.  Our target represents a P/E of 13.6.  Given that the index covers a pretty broad market, we derived our forward P/E from a PEGY of 1.0 based on the 5-year earnings CAGR consensus of 11.33% plus the current dividend yield of 2.31%; and applied it to the CY '15 and CY '16 earnings estimates.

That operating earnings multiple gives us a 1527 - 1794 valuation range.  We are only in the second month of Q3 '15, and for this reason we took the median of that range, resulting in a 1660 valuation of S&P 500 for the next four quarters; 12.3% below where the market is currently.  We note that applying the same multiple to total earnings over the next 4 quarters (2H '15 and 1H '16), results in a 1674 target, comparable to our 'official' 1660 target.  

Yes, as many say, this time it may be different from the Great Recession.  However, the difference is that nearly all central banks globally have intervened, so there may not be too many options left on the table.  We are not saying that the market and the economy are doomed, but we still believe until the 'central bank premium' gets priced out, there remains significant downside.

Performance of AMBlog Index

Lastly, we thought to display the performance of our long recommendations compared with a couple of indexes/benchmarks (below).  We've been fortunate to have outperformed the market even with the latest 10%+ decline from the all-time highs. 


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