S&P Fair Value Estimate - October 1, 2007
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Corporate earnings of the stocks that make up the S&P 500 continue to grow at rates above that of their respective stock prices, further boosting “fair value” for the S&P 500 index over the intermediate term, based on our quantitative valuation model. In fact, at present fair value remains more than 50% higher than the index’s current price of 1526.
Even given the fact that corporate profit margins remain at historically wide levels, the disparity between our model and the market’s current trading range suggest that investor hesitancy remains a strong head-wind for stock prices.
There are two ways in which the discrepancy between current stock levels and our fair value estimate can come back in line. Clearly the market could rally sharply to make up the difference. As noted above, it would take an immediate spike of better than 50% to close the gap, or a move of better than 70% over the coming year, given today’s expectations for one-year forward earnings levels.
Second, corporate profit’s could either stagnate, or outright fall. Either of these scenarios would likely be caused by increasing employee wages & benefits and/or supply costs that can’t be passed onto buyers – thus negatively impacting profit margins.
In our opinion, the resolution will likely be a combination of higher stock prices, coupled with tighter profit margins. Supporting this view, the September employment report released on October 5th, points to a tight labor market (unemployment rate of 4.7%) and moderately rising wages (0.4% month-over-month).
When compared with 10-year
