“Davidson” submits:
Twenty years ago, I read Knut Wicksell’s work from 1898. He theorized that there was a natural rate one could apply to markets, a capitalization rate, that over multiple cycles would provide a valuation analysis that would provide for fair estimation of market pricing. It in theory would identify periods of over- and under- valuation and reduce speculation during which many suffered capital losses. Wicksell did not have sufficient data at that time as is available today. Using the long-term US Real Private GDP(RPGDP) growth long-term and the Dallas Fed’s 12mo Trimmed Mean PCE one can capitalize the long-term earnings trend at any point to arrive at a fair value for the SP500. The Value Investor Index(formerly the Intrinsic Value Index) was constructed using the formula:SP500 Earnings Trend/(RPGDP + 12mo Trimmed Mean PCE) = Natural Price of SP500.The first chart shows this result. The second chart shows the SP500 earnings trend which comes in at 6.1% annually. This index was useful in making investment decisions near SP500 lows and was particularly helpful during the Sub-Prime Crash in Mar 2009. It also held up for a sharp correction in 2019 and again during the COVID shutdown. But then a new set of technology issues caught investor’s attention and the SP500 soared as the Mag 7 became favorites. It was then the SP500 became priced at 100% premium to this index. The SP500 was bifurcated with well-known tech issues pushing 10x Price/Sales, some even 20-40x Pr/Sales, while the remainder of the SP500, still excellent companies, saw their valuations tumble. A pattern emerged early on with insider buying that I use today. Whenever the SP500 price dropped to this index, insiders buying accelerated. Insiders have the best information for their respective companies and are considered the best Value Investors. Thus, the name changed to The Value Investor Index. That insiders continue to buy shares whenever their company shares are depressed has always been a Hallmark of most investors missing the better values during pessimistic periods. It is a tool I deploy continuously.
As to this index being a general indicator of value for the SP500 and markets by proxy, the SP500 has moved to a 100% premium post-COVID. The same occurred in 2000’s Internet Bubble before its massive correction. However, this time insider buying continues to identify many companies with decent management teams that are not part of the extreme valuations displayed by the MAG 7. That many companies are depressed even with growth/recovery post-COVID shows in my opinion a loss of fundamental analysis in the marketplace. Instead, we have nearly exclusively analysis based on price movements up or down. That the SP500 is priced at 100% premium to this value-type index shows it is dominated by Momentum investors in only a few issues. Furthermore, these few issues, the MAG 7 and related, are not a fair measure of the underlying economic growth that is present in nearly all SP500 issues.By my analysis, the markets will continue to rise in value till delinquency rates rise hit prior recession-causing levels. That may be 4-5yrs yet into the future with the current trend of this administrations pro-business policies. But once consumers have over levered the next market correction will likely prove as bad or worse than the 2000 correction. That correction was ~50% depending on which peak and which low price one wants to select. Meanwhile, even with the SP500 at a 100% premium to The Value Investor Index, there remain many good companies with good management teams that remain buyable. I recommend these while at the same time recommend against the MAG 7 that institutional investors, the news media, and analysts still seem to prefer to the exclusion of the rest of the SP500.