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Kass: Fair Market Value Update

Scenario No. 3 -- Below-Consensus Economic Growth (probability stays at 55%): The U.S. experiences a disappointing sub-1.5% real GDP growth rate, Europe experiences a medium-scale recession, and China's economic growth modestly disappoints relative to expectations. The Fed announces a plan to expand its buyback of U.S. Treasury bonds in addition to mortgage-backed securities -- the policy has a modestly favorable impact on aggregate growth. Either party wins in something less than a close election. The fiscal cliff is reduced by less than half (to $275 billion to $350 billion). The S&P 500 profit forecast for 2013 is reduced to levels slightly below 2012's results and to a below-consensus range of between $95.00 and $97.50 per share, as corporations' pricing power is limited and profit margins are pressured. Stocks, valued at 14x (up from previous 13x multiplier) under this outcome, have 5% downside risk over the next eight months. S&P target is 1345.

Scenario No. 4 -- Muddle Through (probability stays at 40%): The U.S. muddles through, with 1.5% to 2.5% real GDP growth, and the European economies suffer a modest (but contained) business downturn. China's and India's economies grow in line relative to consensus forecasts. The Fed announces a plan to expand its buyback of U.S. Treasury bonds in addition to mortgage-backed securities -- the policy has a modestly favorable impact on aggregate growth. My baseline case of a comfortable Obama presidential victory, Democrats keeping control of the Senate and the Republicans retaining control of the House comes to pass. The fiscal cliff is reduced by half (to $275 billion). S&P 500 profits for 2013 trend toward a range of between $100 and $103 per share as some modest margin slippage occurs (coincident with escalating inflationary pressures). Stocks, valued at 15x (up from previous of 14.25x multiplier and near 50-year historic average) under this outcome, have 8% upside over the next eight months. S&P target is 1520.

How Do I Use My Fair Market Value Exercise in Actual Practice?

I use this exercise as a guide to portfolio management.

The natural question to ask is, If I believe (as I currently do) that the market is fairly valued at 1411, why be 50% invested in equities in a long-only portfolio?

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