S&P 500 Intrinsic Value Update
The Dallas Fed released its measure of inflation late last week with the August 2013 12mo Trimmed Mean PCE coming in at 1.3%-see the table below. The report can be found at this link: Dallas Fed PCE. This value is used in my calculation of the SP500 Intrinsic Value Index-see chart below.
The Dallas Fed said:
“As always, our rule-of-thumb forecast for headline PCE inflation over the next 12 months is the current 12-month trimmed mean rate. We thus expect headline PCE inflation to average 1.3 percent over the coming year.”
The SP500 ($SPY) Intrinsic Value Index is the long term earnings trend of the SP500 divided by the value of the long term Real GDP trend + 12mo Trimmed Mean PCE = “Prevailing Rate”. The SP500 Intrinsic Value Index came to be through the application of Knut Wicksell’s theory of a “Natural Rate” for investment returns stated in 1898.
The history of the SP500 Intrinsic Value Index closely follows the SP500 from 1978 till 1995 when Hedge Funds became a dominant factor in market pricing. After 1995 Hedge Fund Momentum Investing has resulted in substantial moves above and below the SP500 Intrinsic Value Index. My observations in using this index, lead me to believe that it tracks the buying behavior of the better Value Investors such as Warren Buffett, Wilbur Ross and others who buy stocks based on asset values and anticipated future earnings power while the majority of investors are selling due to an uncertain future. The bulk of investors buy stocks on existing Earnings, Cash Flow and Free Cash Flow trends which are often not visible when Value Investors buy.
The SP500 Intrinsic Value Index value today is $1,893 compared to the SP500 at ~$1,675 or a 13% discount. The SP500 Intrinsic Value Index reflects a fully functioning economy and therefore is expecting a full recovery in Residential Housing and Commercial Construction sectors of our economy. Projecting forward to Dec 2018 when I expect the current economic cycle to peak, the SP500 Intrinsic Value Index is calculated to be $2,630. How the market actually trades at that point and how it progresses in getting to Dec 2018 is dependent on unpredictable geopolitical events. Also how investors view economic trends and the reflection of this in their investment outlook is unpredictable. But, if investors in the last two market cycle peaks at 100% and 55% premiums to the SP500 Intrinsic Value Index repeat their behavior, then the SP500 can be sizably higher than we see it today.
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