Stock market value determination is fundamental to an investor interested in purchasing portions of the market at a reasonable price. Forecasting is an important part of any active investment style.
“The cost of a thing is the amount of what I will call life which is required to be exchanged for it, immediately or in the long run.”
― Henry David Thoreau, Walden
The time spent understanding a situation is the ‘life’ Thoreau mentions in the preceding quote. When considering the cost required to value the market, lets look at ways that capitalize on the amount of time required in exchange. This post will discuss a little wisdom from Benjamin Graham, some analyst reports one might consider, and some current trends in the news.
A Thought from Ben Graham
Benjamin Graham used the price to earnings (P/E) ratio to identify when a security was over priced or priced at a discount. A simple way to look at this is to compare the P/E ratio’s current level to that of the security’s average. When the P/E is lower than the historical average P/E, then Graham proposed that the price of the underlying security is trading at a discount. Historical data that identifies the monthly average P/E of the S&P 500 to be roughly 15.60 (from data found on www.multpl.com). This is the average of over 100 years’ of data. Note that over the past 20 years this average is trending upward. This indicates that if the S&P 500 drops below a P/E of 15.60, then it is at an appropriate entry price. The S&P 500’s current P/E ratio of 24.98 (found on wsj.com) would indicate that the average is about 60% overpriced.
Professional services share their perspective of where they expect the market to be heading. My personal favorite is the Value Line Investment Survey, but there are others to consider. Warren Buffet was once quoted stating that he liked the S&P report. These companies that do this type of work are not all the same so if you are using their information make sure it is from a reputable organization.
Value Line’s weekly report indicates the anticipated price change for the stocks in the Value Line survey will be over the next five years. The highest expected five year return was 185% during the financial crisis, last week it was 35%. Value Line uses a proprietary arithmetic formula for its calculation and the investor will have to pay for such advice-or get access to it at a local public library. Most public libraries will have this in their section on investing.
The S&P Capital IQ Outlook report is another paid service. This report is free to those with a TDAmeritrade account. The S&P outlook for 2017 states that the current bull market is the second most expensive market top since WWII with a trailing (meaning the last 12 months) P/E of more than 25x! The Outlook report also points out that the S&P 500 fell an average of 2.7% during the first year of a new Republican president. The report states that only once did the year following the election of a new Republican president end with a gain. Finally, S&P predicts that this market will continue to stay ‘aloft’ through the next year.
The Argus Market Watch Report is also free with an account from TDAmeritrade. This report compiles several different analysts and provides a diary of a 12-month forecast for the S&P 500. This forecast puts the price of the S&P 500 to be somewhere between 1,800 and 2,250. The S&P 500 is currently trading just over the high end of this range. Argus does not appear to have updated this range since December 2015, making any confidence in this prediction low and leading the reader to question how current it is.
These agencies can be wrong they provide predictions because their customers ask for it. In fact there exists a strong argument to anyone wanting to lay some blame of the financial crisis at various rating agency’s feet. They also use words that try to make their predictions less clear like the S&P report use of the word aloft. However, they do give a good idea of the sentiment that is current in the market and most of their customers want to see the logic behind such predictions.
Stories in the news talk of the way people are piling in on the purported “Trump trade”. The “Trump trade” is the price jump that occurred in the US stock market after the election. This price jump was sharp and had very few losses over the past few weeks. This indicates that the index may be overpriced.
My experience with P/E ratios, professional advice, and news articles teaches me that this data needs confirmatory evidence. The evidence I considered for this post causes me to conclude that the stock market is currently trading at a premium. This post ends with my personal assessment of the S&P 500 price expectation in the next six months. Confidence level: MODERATE, I assess that the S&P 500 has a 70% chance of retreating at least 10% (or to $2,033.07) at some time in the next six to twelve months. Note: this assessment is my attempt to identify market prices over the given period, I use this type of conclusion for my own investing. Before you commit funds to any investment or trade, I encourage you to do your own analysis of the investment vehicles you are looking at.
ACTION ITEM: What price changes do you think will happen in the stock market over the next six months to a year?