Kass: Fair Market Value Update
Below are the criteria and methodology I use to evaluate the S&P 500 and upon which I conclude that fair market value is approximately 1415, up from my prior forecast of 1390 and almost exactly at Friday's close of 1411.
Scenario No. 1 -- Economic Reacceleration Above Consensus (probability stays at 2.5%): The pace of U.S. economic recovery reaccelerates to above-consensus forecasts (3%-plus 2013 real GDP growth) based on pro-growth fiscal policies (following a grand political compromise) geared toward generating job growth, corporate profit margins being preserved (with low inflation and contained wage growth), interest rates remaining low and durable spending (housing and autos) recovering sharply as pent-up demand is unleashed. The $550 billion fiscal cliff is whittled down to only about $150 billion, subtracting less than 0.5% from 2013 real GDP. Europe stabilizes (and experiences only a shallow recession), and China has a soft landing (with 2013 GDP growth tracking in excess of 8%). S&P 500 profit estimates for 2013 are raised to a range of between $110 and $113 per share. Stocks, valued at 16x (compared to previous 15.5x) under this outcome, have 26% upside over the next eight months. S&P target is 1785.
Scenario No. 2 -- Recession (probability stays at 2.5%): The U.S. enters a recession precipitated by a loss of business and consumer confidence, which produces a fall in manufacturing output and personal consumption expenditures. The Democratic and Republican parties grow more contentious, partisan and unequivocal in position following a very close election won by either President Obama or Governor Romney. The schism between the two parties persists, leading to rancor similar to the summer debt-ceiling deliberations and acrimony of August 2011. Confidence deteriorates further, and the housing market seizes up as bank lending becomes more restrictive when the fiscal cliff is not remedied/addressed -- the fiscal drag to GDP is -2% to -3%. The Fed announces a plan to expand its buyback of U.S. Treasury bonds in addition to mortgage-backed securities in the first half of the year, but more easing fails to contain the economic weakness caused by a developing negative feedback loop. A series of European bank failures and EU sovereign debt defaults contribute to a deepening European recession and a hard landing in China and India. S&P 500 earnings estimates for 2013 are materially reduced to a range of between $70 and $80 per share. Stocks, valued at 12.5x (up from previous 11.5x) under this outcome, have 33% downside risk over the next eight months. S&P target is 940.
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