Kass: Fair Market Value Update
This year, the S&P 500 dramatically eclipsed my calculations of fair market value, owing to both an expansion in P/E multiples and a better corporate profit performance. (One third of the S&P's better rise was due to higher profits and two thirds was due to an expansion in multiples.)
A year ago, my baseline expectation for 2013 S&P profits was between $100 and $102 a share.
Today, as we near year-end, the consensus estimate for 2013 S&P earnings is $109 a share. I am now at a below-consensus forecast of between $107 and $109 a share.
For 2014, the consensus estimates that the S&P 500 will achieve profits of about $116 to $118 a share. My base case estimate is for $112 to $114 a share, a gain of under 5% (year over year), which is, again, below consensus.Slowing sales, a contraction in margins, the reduced influence/benefit from aggressive monetary policy and political uncertainties are some of the reasons why my baseline earnings expectation are for below-consensus 2014 S&P 500 profits. Today's new fair market value calculation of 1645 incorporates the following:
- the melded probability distribution of my four scenarios (below);
- reflecting the continued and surprisingly low-interest-rate environment, I have increased the P/E ratios applied to each of the four outcomes from my previous fair market value calculation; and
- profit forecasts for 2013-2014 have been revised upward to reflect what has been reported and earned thus far in 2013.
"A good forecaster is not smarter than everyone else; he merely has his ignorance better organized." -- AnonymousBelow are the criteria and methodology I use to evaluate the S&P 500 and upon which I conclude that fair market value is approximately 1645 (it is overvalued by about 5% compared to Friday's close of 1740). Scenario No. 1 -- Economic Reacceleration Above Consensus (5% probability): The pace of U.S. economic recovery reaccelerates to above-consensus forecasts (3%-plus 2014 real GDP growth) based on pent-up demand in nondurable spending (cars and autos), rising consumer and business confidence and a sustained period of low interest rates. Corporate profit margins are preserved. The Fed begins tapering in January 2014. European economic growth rises to above 1% in real terms, and China's growth rate exceeds 8%. The disruptive influence of our politicians in Washington, D.C., is diminished and fails to adversely influence business/consumer behavior. The yield on the 10-year U.S. note exceeds 3.5%. S&P 500 profits for 2014 approach $120 a share. P/E multiples average 16.5x, producing a 14% 12-month upside. S&P target 1980.
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