Across the five valuation methodologies that Goldman's David Kostin uses to consider the S&P 500's richness, the current price (around 1600) represents the average. While the Fed Model (bond vs stock value) is the one significant 'framework' suggesting upside potential but as Kostin notes, it is bonds that are more mispriced than stocks and the gap could close from bond side (significantly reducing the upside potential of this model). His macro-valuation framework, as well as the ROE vs P/B relationship and the Discounted Dividend Model all suggest year-end 2013 fair value at around the current price (i.e. 0% upside). And remember, as we noted recently [9], this 'expectation' still relies on the H2 2013 rebound in GDP and implicitly EPS (+28% in Q4 2013!) that is so hoped for.
Via David Kostin,
S&P 500 surged 2% this week and has now rallied 14% YTD to 1614. P/E multiple expansion explains the majority of the market’s rise as EPS revisions have been negative. Most investors have lagged the index and have turned their attention to identifying tactical opportunities.
Investors have been frustrated as they seek alpha opportunities within a beta market.
S&P 500 now trades near fair value based on a variety of approaches. Our macro valuation model, the ROE vs. price/book relationship, and our DDM all suggest year-end 2013 fair value of roughly 1625 (see Exhibit 1). The Fed model points to a large gap between bond and stock values that could close from either side. We believe bonds are more mispriced than stocks and recent P/E expansion may show investor preference for equities.
The bulk of earnings season is now behind us, with 85% of S&P 500 firms having released 1Q results. Earnings growth was just 3%, and five of the ten S&P 500 sectors posted year/year declines in EPS. Consensus sales and earnings revisions since the start of the year have been negative for both 2013 and 2014. Our top-down EPS forecast remains at $108 for 2013 and $116 for 2014 while consensus forecasts $110 and $123.
Many equity investors are skeptical US GDP growth can reaccelerate during the next year to a roughly 3% pace. Recent US economic data has been disappointing as seen in negative US-MAP scores. The ISM fell to 50.7 and today’s better-than-expected payrolls report included only 165K new jobs.
S&P 500 is at 'fair-value' (and rich against macro and earnings reality)...
[10]
and revisions have been downright horrible for a year now (as equity performance has ignored that reality)...
[11]
You just need to believe... in consensus expectations of 28% growth in EPS in Q4 EPS!!
[12]
even as top line growth remains benign...
[13]
but of course - the only thing that matters is whether your central bank is printing money (coincidence that the best 2 performing equity markets year to date are US and Japan?)
[14]
Charts: Goldman Sachs