I thought you might like to see how having a base value indicator for the S&P 500 (.INX), i.e. SP500 Intrinsic Value Index can lend some confidence to the future.
Remember that the S&P 500 Intrinsic Value Index comes from more hours than I can count of studying Value Investor behavior. This index represents the long term mean earnings for the SP500 ($SPY) which is capitalized by the long term trend of US GDP which comes from a long term Real GDP trend and has the 12mo Trimmed Mean PCE (Dallas Fed core inflation measure) added to it.
My observations are that inflation is not predictable but can be measured and that Real GDP which has a good long term trend can be measured and predicted forward if one has read US history and developed confidence on our ability to recover from financial errors. If you have studied our society’s history and compared this to our financial progress, you will come away with high confidence in our ability to “right the ship” even though it is our political system which throws it of the track periodically. One cannot develop this type of confidence in making investment decisions any other way! But, once you gain the insights which come from the process, you will see things much more clearly and you cannot help but have confidence even though we make countless errors. You will come to appreciate the resiliency of human beings and “read” this in the long term earnings of the SP500 which are an incredibly consistent 6.1% compounded rate of return since the 1940s.
What I have done below is to take the S&P5 00 Intrinsic Value Index and extended it thru Dec 2018. This index represents the level at which the few, but good Value Investors like Buffett, Ross, Castle and etc buy equities vs. the long term earnings stream. This chart comes with several “Ifs”.
1) The biggest “If” is the rate of inflation-I used 1.3% the current rate from the Dallas Fed and projected forward.
2) If inflation increases, then the projected S&P 500 Int Value of $2,590 in Dec 2018 has to be discounted accordingly.
3) History shows that markets have mostly factored in inflation at the lows not the tops, i.e. only when Value Inv. are buying.
4) The last big “If”-Value Investors continue to repeat creating market lows and Momentum Investors create the highs as in the past.
With these “Ifs” in mind, one can use this chart to invest today knowing that continuous monitoring of the markets and investor behavior is required to assure that the prediction is justified. Today we remain well below the historic pricing and well , well below the pricing which has developed since Hedge Funds entered the scene as a significant market influence.
If the past repeats, then the SP500 should at least reach ~$2,590 if this is where the economy peaks. If Hedge Funds repeat their momentum Investing activity as we saw in the last to market cycles then we could see 50%-100% pricing above the SP500 Intrinsic Value Index. This is a big “IF” and a big unknown. We will know only when we get there!!
1) If the economy peaks in Dec 2018..
2) If Hedge Funds invest as in the past…
3) Then, we could see the S&P 500 priced in the range of $3,885 to $5,180!!
Remember, the most positive market psychology occurs at economic peaks. Whenever the economy reaches a peak, the market will be at its peak. If the economy provides the signs that it is peaking, then no matter whether the SP500 has reached its anticipated price or not, one should sell. Once economic news turns from good to bad, stock prices will be lower. With Hedge Funds there will be no equity asset class which will not be sold lower! The only course is to go to low, low credit risk fixed income with the strongest historical currency. In my work this brings one to the 5yr US Treasury.
The correction, should this upside over-valued price forecast for the SP500 transpire, will be on the order of 50%. You will be fired if you do not grab most of the gains the markets could provide in this sequence. You will be fired if you did capture the upside return but did not exit when it was appropriate. To keep investors satisfied and to get referrals, you will have to be able to navigate nimbly and keep your clients comfortable and confident that you know your way around markets.