With resilient earnings and upbeat earnings guidance, the S&P 500 (INDEXSP:.INX) may still be slightly undervalued, even with rising investor sentiment, according to a note from Citi’s chief U.S. equity strategist Tobias Levkovich.

Levkovich, joined by Lorraine Schmitt and Christina Wood, looked at the earnings yield gaps for both Treasury futures and Moody’s Baa corporate bonds, and found that they showed slight devaluation. “At one-to-two standard deviations below its 40-year weekly average, the market outcome statistics remain bullish over the next 12 months,” Levkovich wrote. His analysis showed a 90 percent chance that the S&P 500 (INDEXSP:.INX) would gain in the next 12 months, and 70 percent that it would gain over the next six months.

Undervaluation may be a surprise

But while the chance of growth is high, the actual undervaluation is quite small, just 0.19 or 0.18 standard deviations below the rolling mean, depending on whether you look at Treasury bonds or Baa corporate bonds.

market earning yields gap

This slight undervaluation may come as a surprise to many analysts who are taking a second look at the S&P 500’s rapid growth toward the end of Q2, and wondering if it can be supported by actual p/e. But Levkovich points out that investor sentiment is being driven by a complex set of unexpected news over the past quarter including mixed sentiment on Fed tapering, the controlled slowdown in China, upward earnings revisions and developments in the ongoing European sovereign debt crisis.

Fund managers trying to wring value out of current market

Levkovich has also said that fund managers are on a “sellers strike” while they try to get as much value as possible out of current market conditions, though he now seems to be suggesting that their bullish instincts are correct, even if the numbers are close to parity.

The other big news is that liquidity in equities continues to increase, with the four-week moving average of equity inflows went up from $3.95 billion last week to $4.08 billion this week. In the last week of July, investors added a total of $714 million to equity funds, though bond funds saw $6.94 billion in outflows. Citi’s Panic/Euphoria inched slightly higher, from 0.31 to 0.32, holding steady on the ‘euphoric’ end of neutral. If it goes much higher, it could be time to start talking about a possible stock bubble.