For those who follow my rants, you’ll recall (okay, you probably won’t recall) my proprietary method of estimating where the S&P 500 Index should be headed. If you scan very old posts of mine, you’ll notice that this has served me remarkably well. It also served me well doing my job while managing portfolios and making asset allocation decisions.
You can do this on the back of an envelope and it is based on the most simple of time value of money concepts. Consider the earnings from a stock, or an index as a perpetuity (meaning no growth) which seem unrealistic in the long term, but very frequently investor expectations become confused and its as good a forecast as any if only for brief periods. The P/E ratio of the stock or index provides us with what I consider to be the best number to use for trailing earnings.
The current P/E ratio (see difficult to read table) according to the WSJ is seems to be about 20X trailing estimated earnings of 161.53 using Ed Yardeni’s numbers (see chart), given the level of the index at today’s close is 3248.92. This valuation seems reasonable enough, BUT what if next year’s earnings are actually 10% lower due to Coronavirus and and subsequent fallout – or something around $145? This would put the P/E at a slightly higher 22X earnings. Assuming investor sentiment is miserable soon, then expecting this earnings to not grow at all, and discounted in perpetuity (I never said my approach to this was rational – only that it works) at 5% would mean an S&P 500 target (for me anyway) of 2900.
In summary, I expect the market to correct at least 10% to 11% and it seems to be on its way.
The only risk to an even worse scenario is a wholesale disposition of the tech darlings (which account for a big weight of the market’s capitalization), or interest rate hikes. The former is a possibility (high beta babies) but the latter would seem unlikely with the global economy suffering from a variety of supply chain, consumer and production bottlenecks already becoming evident.