I've posted this elsewhere but I am hot to get as much input as I can on this>>>
To all:
This is a long post but I would appreciate all of your input. I have come to really value
the opinions on this and other boards.
I find my own sentiment shifting over the last few days. I was quite proud of myself for
calling the fall in late October and I became a card carrying bear for the first time in my
investing career. The big question, though, was whether we were having a correction
or the real thing. I was leaning toward a correction, and I was hoping for 15% on the
S&P 500. Then, as I learned more about the world, the economy and the market
(thanks in part to the excellent posts on this thread), I started thinking we were in for a
meltdown. I then got greedy on the downside and paid for it over the last few days.
Well, I am reassessing, and here is what I see:
Valuation: Yardeni calculated a fair value for the S&P of 802 in September based on
the FED model for estimating fair market value. This is what I was basing my 15%
correction on.
However, this model, which has been pretty accurate over time, has two variables, 1)
12 month ahead earnings expectations for the S%P 500 and 2) yield on the 10 year
bond.
Well, lets look at it now:
earnings estimates for S&P 500(I\B\E\S as of last week )= $50.37
10 year bond yield = .058
S&P fair value = 50.37/.058 = 868
By this model, overvaluation is 7%
I like this model very much. it is simple, and it takes into account quite a few
fundamental issues pertaining to the economy, as forward earnings and current bond
yields are the sum results of a tremendous number of variables. These two numbers
distill the whole gestalt and in the formula give a fair idea of value based on what an
investor (not speculator) should be willing to pay for the S&P to get a fair relative
return (the earnings). Anyway, good enough for Greenspan, good enough for me.
So, by this measure we are not as overvalued as we were. The real question is what is
going to happen to those two numbers.
This is where the real speculation comes in. You can make your decision on your
stance on the market depending on where you think these numbers are going.
I am more optimistic now as I see the numbers rolling out. It seems to me we may have
hit the sweet spot as far as the economy goes.It really doesn't get any better than this,
at least on the domestic scene. However, we are in a flat inflationary environment due
to the tremendous production capacity in the world. Companies cannot raise prices.
Wage pressure is building also. These should affect earnings negatively so how do I
reconcile my optimism?
Thanks in large part to growing productivity, companies can make more with less.
Greenspan has put this forward in the past and the recent numbers confirm this trend.
Some of the big layoffs are the result of this and will go to the bottom line. However,
those laid off workers seem to be able to find jobs. Everyone is working, so there is a
fair amount of cash and buying power out there. But, people are a little nervous and so
aren't blowing it all in a spending frenzy. They are going to spend it though. And they
will get very good prices when they do spend it. So I think there will still be an increase
in demand for most things, at least in this country and in Europe, high tech stuff being
particularly in demand, as it is becoming "necessary" both at the consumer and business
levels to have it.
Becuase we and the world can be so productive, there is little chance of inflation,and a
risk of deflation, even with wage growth. The slowdown in Asia and SA should also
contribute to this. So I think that bonds are going to come down, lowering the
denominator of the Fed model.
However, I do think there will be some lowering of the forward earnings estimates due
the lack of pricing power and the Asian and SA problems. This lowers the numerator.
The BIG Question is how much will these two numbers change. That is what I am
counting on from all you geniuses out there. I'd love to hear what Iqbal, Mohan,
Bonnie, Joan, Zeev, Bilow, Ground Zero, rrman,
Dan, tekgk, tommaso, Defrocked, Larry and everyone else out there thinks about
these two numbers.
Here is my estimate:
I think earnings estimates will come down. This year so far earnings have been about
$45, I think forward estimates will come down from $50 to about 47.50.
I think bonds will drop. With inflation about zero, I wouldn't be surprised to see the 10
year drop to 5% but I will be conservative and use 5.5%
So, 47.50/.055 = 863 fair value of the S&P
To show the power of bond yields, if the 10 year drops to 5%
we get a fair value of 47.50/ .05 = 950
With my estimates of 860 fair value we are only 8% overvalued. Not short country
IMHO. I will cover my shorts in SPY on Monday. I will be net long but have about
30% cash. I'm going to concentrate my longs in the techs, as they are the most beaten
down. As the market goes up, I will increase my cash position (synthetically with SPY
shorts or by selling) If the market goes down I don't think I will start buying until we
are below the fair value level.
I am comfortable with a lot of cash because in a low inflation, possible deflationary
time, cash won't lose value and even in a money market account increases in value
relative to inflation.
Thanks for your patience with this long post. I look forward to hearing from you folks.
Karl |
