The past few days have not been kind to the S&P 500 and emerging market indexes.

Emerging markets have tripped up again and their political and currency woes are said to have triggered a global sell-off.

Mid-January, a Goldman Sachs analyst dampened bullish enthusiasm somewhat with a report to clients that said “S&P 500 (.INX) valuation is lofty by almost any measure. We believe S&P 500 (INDEXSP:.INX) trades close to fair value and the forward path will depend on profit growth rather than [price-to-earnings] expansion.”

Nouriel Roubini, aka Dr. Doom, gave a boost to the bearish camp by tweeting that a new black swan event could arise out of Sino-Japanese hostilities:

1-roubini-black-swan Equities

Admittedly, that is not a valuation issue, but for bears it was grist to the mill.

 S&P 500 overvalued

The BofA Merrill Lynch Fund Manager Survey for January found many respondents concerned about high equity valuations. “The overvaluation view is driven predominantly by the views on U.S. equities where a net 72% say stocks are overvalued,” says the press release.

The S&P 500 (INDEXSP:.INX) slid nearly 3% towards the close of last week and is now 3.27% off its all-time high.

 S&P 500: Citi’s counterpoint

“A number of metrics ranging from normalized earnings yield gaps to price/book and the P/E Bull’s Eye intimate that further upside is quite plausible even as the present value of flat earnings into perpetuity would imply more of a fair value mantra,” say Citi analysts Tobias M Levkovich, Lorraine M Schmitt and Christina Wood in their recent research note ‘Valuation Consternation Meets Investor Hesitation.’

Not only that, the Citi analysts also suspect that the clamour regarding overheated valuations is in fact music to the ears of (a) those that missed this gigantic rally, and (b) fund managers sitting on the fence (as well as on cash) and looking for a better entry point; “an adoring audience,” in Citi’s words.

Citi: More useful to focus on lead indicators, not the abstract

On the chart of the S&P 500 (INDEXSP:.INX) Trailing PE below, Citi analysts observe that the “concept of overvaluation may be overdone” given that trailing PE is just marginally above the historical average and that projections of PE based on 2014E EPS (red dot) and on 2015E EPS (green triangle) are below the average.

“With both buy side and sell side expectations for EPS growth in the high single digits and low double digits, respectively, there is room for price appreciation,” say the Citi team.

2-trailing-PE Equities Equities  S&P 500
S&P 500

On the chart of the normalized earnings yield gap below, they comment that “there is still a 91% chance of gains in the next 12 months for share prices.”

3-earnings-yield Equities

Don’t spook investors

Earnings upside seems well supported and there is cash on the sidelines that should come in on dips. While fears about margins persist, one has to be reminded that there is EBIT margin improvement potential out there given that eight of the 10 S&P sectors are posting profitability levels below the prior peaks of 2007, providing some operating leverage potential as revenues pick up. Yet, somehow that very important fact gets left out when there’s a desire to scare the investment community with poorly researched arguments,” say the Citi analysts candidly.