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Kass: Fair Market Value Update

This column originally appeared on Real Money Pro at 7:21 a.m. EDT on July 18.

NEW YORK ( Real Money) -- In large measure, the worsening macroeconomic situation in Europe, China and the U.S. is leading me to reduce further my calculation of the S&P 500's fair market value from 1430 to 1415, which is still about 4% above the cash level at Tuesday's close of trading (1363).

  • I am keeping the chances of the two tail events -- namely, a reacceleration of U.S. growth and a U.S. recession in 2013 -- at 5% each.
  • I am increasing the probability of sub-1.5% 2013 real GDP growth from 35% to 40%.
  • I am reducing the likelihood of my baseline, muddle-through scenario (defined as 2013 real GDP growth of between 1.5% and 2.5%) from 55% to 50%.

My base case of muddling through now holds a 50/50 probability and yields an S&P 500 price target of 1540, far higher than my fair market value calculation of 1415 and well above cash (1363). The probability of muddling through, however, has been lowered twice over the past five weeks and could move still lower in the next month, due to the continuation of a weakening domestic economy and the superficial bandages applied to the eurozone.

Below-consensus growth (scenario No. 3 below), which is now accorded an increased 40% probability (the second-highest), yields an S&P 500 target of 1290, below both the current level of S&P 500 cash (1363) and well under my 1415 fair market value estimate. (These two most likely outcomes account for a 90% probability.)

S&P cash closed yesterday at 1363. In all likelihood, I expect the S&P 500 to be contained within the range between 1290 and my fair market value of 1415 over the balance of the year, representing a slightly negative imbalance between reward and risk. This yields a generally underwhelming and less-than-compelling investment equation. Taken literally, this would mean that there are about 70-75 S&P points of risk and about 50-55 S&P points of potential reward. (In other words, there will be a premium on individual stock selection over market risk-on/risk-off decisions in the months ahead.)

Today's recalculation of my S&P 500 fair market value of 1415 is about 70 S&P points, or only 5%, from my highest calculation (of 1485) back in April.

My methodology, though appearing precise, recognizes the difficulty of attaining investment precision given the numerous moving parts (economic, interest rates, sentiment/psychology and exogenous factors) in its calculation. It is intended more as a thoughtful guideline (of reasonable expectations/outcomes) than an exercise that should be taken literally. (I strongly recommend that subscribers input their own probabilities and outcomes in order to produce their own market expectations.)

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