S&P 500 Valuation Based on Inflation Data


“Davidson” submits:

The Dallas Fed reported the 12mo Trimmed Mean PCE(Core Inflation) at 1.4%. Their table is reprinted below with some of their commentary. Below is the chart of the SP500 ( SPDR S&P 500 ETF Trust (NYSEARCA:SPY)) vs. the estimated SP500 Intrinsic Value with the end of March S&P 500 Valuation (.INX) at $1,515 and SP500 Intrinsic Value at $1,745.

S&P 500 Valuation

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The market is historically priced higher with falling inflation. My research leads me to view inflation as dependent on market psychology. When we as a society are worried about the future, we tend to hoard cash, reduce our spending and inflation falls. Like today!! When we are more buoyant about the future and eager to accumulate goods or we feel that future dollars will not buy as much, we spend freely and even expand our use of credit thus we cause inflation. Like what government and society did during the 1970s!!! Historically, stock prices fall when inflation rises and rise when inflation falls.

Lower inflation results in higher equity prices all things being equal. In the PCE Table below, the trend is for lower inflation.

Since 1978 the SP500 Intrinsic Value Index calculated using the “Prevailing Rate”(Real GDP Rate + 12mo Trimmed Mean PCE Rate) as a capitalization rate for the mean earnings for the SP500 has been a helpful indicator in judging SP500 under/over valuation levels.

From the Dallas Fed:

“The trimmed mean PCE inflation rate for March was an annualized 1.0 percent. According to the BEA, the overall PCE inflation rate for March was -1.6 percent, annualized, while the inflation rate for PCE excluding food and energy was 0.4 percent.”

“The tables below present data on the trimmed mean PCE inflation rate and, for comparison, the overall PCE inflation and the inflation rate for PCE excluding food and energy. The tables give annualized one-month, six-month and 12-month inflation rates.”

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Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a RealMoney.com contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.

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