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Pastimes : Ask Mohan about the Market

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To: tekgk who wrote (12915)	1/10/1998 11:38:00 AM
From: studdog	Read Replies (3) of 18056

To all: Like many on this thread, I've been generally bearish since September, but have based much of my attitude on valuation rather than any cracks in the economy. My favorite model for valuation is the Fed Model which uses ten year bond yields and analyst's forward 12 month earning estimates for the S&P 500 to come up with a "fair value" for that index. Using this model the S&P has been overvalued as much as 25% and as low as 9% over the last few months. However, the extraordinary drop in bond prices has dramatically altered the valuation landscape: Forward earnings estimates for S&P500 (operating earnings next 12 months)= $50.70 current 10 year bond yield = 5.38% Fed model for fair value of S&P 500 = earnings estimates/10 year bond yield= $50.70/.0538 =942!!!! Sooooo, By this criteria, the S&P 500 is no longer overvalued and is in fact 2% undervalued. The economist Ed Yardeni has a graph of this model vs the actual S&P 500 and there is a pretty good correlation. You can view this at yardeni.com (Click on the box just below "Resouce Center") To maintain a bearish stance I will have to believe in one or both of the following things: 1: The current bond yields are an anomaly and will rise again (Yardeni makes a good case for them to fall further) 2: future earnings estimates will be cut and cut fairly dramatically. (but even if earnings are totally flat with last year (about $47), then the current bond yield still justifies an S&P of 880. still not tablepounding overvaluation.) Having gone through this exersize I am going to cover some of my SPY shorts and get a little more market exposure. If the markets fall I will continue to cover and be pretty long by S&P = 900. If bond yields fall further and/or the S&P gets much below 880 I will go long SPY. Of course an economic meltdown would render all this moot, as earnings will plummet. I am not expecting such a meltdown and I personally don't wish for one. I would appreciate all thoughts from the contributors to this thread. Karl

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