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Politics : Idea Of The Day

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To: IQBAL LATIF who wrote (17008)	2/16/1998 7:57:00 PM
From: studdog	Read Replies (2) of 50167

I am humbled by the tremendous quality and utility of the posts on this thread. I thought I would offer up my own humble thoughts on the the US market in case anyone finds them useful. We keep hearing the chorus of "overvaluation, overvaluation" as an indication of a coming collapse of equities. I have seen calls for correction of up to 25 -30% in the S&P 500 before we would be at "fair valuation" and references to the current market as a "bubble" or "tulip mania all over again". I pretty much subscribed to this idea until I visited the web page of Dr. Ed Yardeni and took a look at the model the Fed uses to come up with "fair market value". see : http//www.yardeni.com/welcome.html (click on the second scrolling banner) This is a simple model and is based on the assumption that fair value is driven exclusively by future earnings expectations and the current interest rate environment. This simple model has correlated with market value quite closely in the last 15 years or so. The formula is: Fair Value of S&P 500 =one year forward earnings expectations / current 10 year bond yields the most recent IBES forward earnings that I can find is $50.7 the current 10 year bond yield is .0547 so, fair value for the S&P500= 50.7/.0547 = 927 This represents a 10% overvaluation. In comparison, in October 1987 the model indicated a 30% overvaluation. If bond yields went to 5% or earnings estimates rose 10% we would be at fair value. The bottom line for me, I believe that the overall market is not cheap but not wildly overvalued. If one thinks bond yields will come down further and earnings will grow, then being long is more than justified. If one believes that earnings are going to continue to grow and bond yields will remain stable than you might expect returns roughly equivalent to the rate of earnings growth. OTOH, if you think bonds yields are going to rise and/or earnings will fall, then the current mild overvaluation will get worse and should lead to a fall. This is all pretty simple but it has really helped me understand what is going on and put a little bit of rationality to current levels. Based on this model I have gone from being pretty bearish and pretty short this past fall to mildly bullish and defensively long currently. I am still interested in capital preservation given valuations but would certainly buy the dips if the fundamentals regarding rates and earnings did not appear to be changing. I would appreciate any thoughts on this approach to market value from the scholars on this thread. Karl

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