To:Raymond Thomas who started this subject
From: greg s Saturday, Jul 20, 2002 11:01 AM
View Replies (2) | Respond to of 168540
Market undervalued, per Fed model -
cbs.marketwatch.com.
Greenspan's kept secret
Commentary: Fed formula says stocks 21% undervalued
By Chris Pummer, CBS.MarketWatch.com
Last Update: 11:19 AM ET July 17, 2002
SAN FRANCISCO (CBS.MW) -- When it comes to testifying before Congress, and by extension the world at large, Fed Chairman Alan Greenspan reached a "don't ask, don't tell" understanding with lawmakers long ago about discussing U.S. stock values.
During his semiannual address to the Senate Banking Committee, Greenspan spoke at length Tuesday about countering the corruption that's undermined investor faith in Wall Street, without ever addressing the manifestation of that breached trust -- the hemorrhaging of stock prices. (Wednesday, the Fed chief testified in the House.)
What the central-bank boss might have said -- if only the world wouldn't interpret it as hometown cheerleading -- is that U.S. stocks are now 21 percent undervalued based on the Fed's unofficial formula for valuing the market.
There are caveats to that calculation, but the "Fed stock valuation model" is the same formula that determined stocks were 50 percent overvalued when the bubble burst in 2000 -- and 34 percent overvalued before the crash of 1987.
Of course, you'll never hear Greenspan issue a "strong buy" recommendation on stocks. After all, even when he warned of "irrational exuberance" in 1996, he framed the phrase in a question, not a statement -- though the world took it as a proclamation.
As the economy's supreme traffic cop, he's inclined to highlight dangerous conditions that could lead to a market crash rather than favorable conditions that may produce a sustained rally. That's why he didn't even hint Tuesday at the recent onset of irrational aversion.
But the Fed valuation model -- first noted in its report to Congress in 1997 -- suggests the market is scraping a bottom.
The formula revealed
Here's how the calculation goes: Take the aggregate operating earnings per share for the S&P 500 for a 12-month period (See S&P Web site for latest estimates), divide it by the interest rate on the 10-year Treasury, and then multiply by 100 to come up with the fair value for the S&P.
As of Tuesday, the total projected earnings per share for the S&P 500 in the year ending March 30, 2003, is $53.82, and the 10-year Treasury stood at 4.71 percent. The division works out to 11.43, which would put the S&P's fair value at 1,143. It closed Tuesday at 901.94, suggesting it's 21 percent undervalued.
The Fed model is considered a better gauge of the market's value than the S&P 500's current price-to-earnings ratio vs. historic norms for two reasons: It takes into account relative returns on bonds and eliminates the debate over whether the P/E benchmark should be higher because of heightened demand for stocks from a broader segment of the population.
Daring to say as much
Of course, suggesting the market is undervalued would be heresy in this environment.
Greenspan had talked tougher than the president a week earlier in hopes, perhaps, of allaying fears rather than eliminating them, as a politician is wont to do. After all, Greenspan knows the entire market is riding on this unplayed card: Just how far will earnings restatements go?
And yet consider this -- the S&P 500's ($SPX: news, chart, profile) total projected earnings for the year ending next March is $495 billion. Even if you knocked 21 percent off that figure -- or $104 billion -- the market would still be fairly valued, according to the Fed model.
And to get to that figure, we'd need to endure another 27 WorldCom restatements of $3.8 billion -- or another 12 WorldComs and a 12 percent downward adjustment by the other 488 companies combined. As jaundiced as we might be, no one is suggesting corporations' book cooking goes anywhere near that deep.
If the economy continues to improve and the market doesn't, Greenspan might well issue a surprise statement on irrational aversion -- and not in the form of a question -- just as he did a surprise interest-rate cut in early 2001 to steady failing nerves.
This too shall pass
For now, he's letting others speak for him. And the chorus is growing. In a Wall Street Journal op-ed piece Monday, former Reagan economic adviser Arthur Laffer estimated stocks, by his measure, are 48 percent undervalued. Laffer ended his piece by saying, "From where I'm standing, it looks as though we're in a very nice market, indeed."
If that estimation from the father of supply-side theory doesn't convince you our stock losses are near an end, at least take solace in Greenspan's view on the root of investors' fear and the catalyst for a market recovery.
"We will get past this corporate-governance issue. It is most unfortunate and, I think, very regrettable, and it has had negative effects, unquestionably. But beneath it all is still a very soundly functioning system, as best I can see it.
"We do have a set of profits data which, for all practical purposes, are free of spin. ... [The national income and product accounts numbers] are improving fairly dramatically, as indeed they must because the necessary implications of productivity growth at a 7 percent annual rate in the average of the fourth and first quarters is very difficult to engender without a very major increase in operating earnings. And, indeed, that's exactly what is happening."
Translation of the quiet man's words: The as-yet-untallied earnings restatements may soon be offset by real profit coming fast on their heels.
Chris Pummer is personal finance editor for CBS.MarketWatch.com in San Francisco. |
