FA SP500 estimation - take your best shot!

S

sportsguy

I try to combine FA data with TA, to forecast the market, to get a glimpse of the future direction or tendency from both a short term basis and a long term basis. . . i have various data series going back 25 years on weekly and daily basis. . . . both technical and fundamental . . . .. after last weeks liftoff, and a CNBC guest mentioning undervalued, i decided to build a SP500 earnings yield versus the 10 T bond yield model. . . here is the historical relationship between SP500 "AS REPORTED" earnings yield (the inverse of P/E) and the 10 yr Tbond Rate. . . . calculated as SP500 earnings yield / 10 yr Tbond yield:

Statistics on Series YIELDSDIFF
Weekly Data From 1978:01:06 To 2002:09:27
Observations 1291
Sample Mean 0.80647636985 Variance 0.048184
Standard Error 0.21950923132 SE of Sample Mean 0.006109
t-Statistic 132.00853 Signif Level (Mean=0) 0.00000000
Skewness 1.21562 Signif Level (Sk=0) 0.00000000
Kurtosis 1.52165 Signif Level (Ku=0) 0.00000000
Jarque-Bera 442.50684 Signif Level (JB=0) 0.00000000

Minimum 0.39813084112 Maximum 1.52684144819
01-%ile 0.45468886171 99-%ile 1.48318362570
05-%ile 0.50818765584 95-%ile 1.32538763276
10-%ile 0.56709956710 90-%ile 1.12062615101
25-%ile 0.67582907175 75-%ile 0.87373225152
Median 0.76694411415

So, using these historical limits, and the forecasted annual earnings to the current qtr, of $29.94, from http://www.spglobal.com/earnings.html , the attached spreadsheet calculates the different limits of valuations for your intellectual stimulation. . ..

Note: using the 3.4% low last week on interest rates, and $29.94 as the forecasted reported earnings for Q3 which are being reported right now, based upon earnings warnings. . . . last week we hit the 90% UNDERVALUED range. . .

sg
 

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The counter argument against this analysis is that when interest rates fall very low, and are used in the divisor, then the answer becomes very large. . . . meaning that the relationship is NON linear. . . however, we do not have many observations to validate this conclusion, but with the view of the graph, the one answer that is clear is that when interest rates are very low, volatility increases. . . .

However, are interest rates so low as to enter the non linear part of the curve that we don't have many observations on? I don't know. . . . but until we get more, this chart can be used as a guideline. . . .

the other part that the model does not take into account is when the investor transitions from looking at the current qtr's annual earnings results to the next period's annual earnings. . . I would suggest that the transition takes place after 75% of the earnings of the SP500 companies take place. . . and the market adjusts its outlook to the next qtr's results, which is part of the future discounting process. . .

currently we are looking at approximately $30 in earnings and 4% interest rate . . . .

tom
 

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