The media continues to amaze me by comparing opinions based on current perceptions of a scandal to George Orwell’s novel Nineteen Eighty-Four. If they are monitoring my phone calls I hope they had plenty of black coffee to help stay awake. In my opinion, this is a one sided topic against deficits while ignoring anything to do about encouraging growth.
Last week the markets took a roller-coaster ride and volatility returned to the markets. After a 300 point swing, the markets ended with an up note. The cause of this was interesting from the standpoint that a not too hot, not too cold employment report quieted the fears of the Federal Reserve letting up on the gas and submarining the economy. The so called experts of financial journalism spent days discussing comments made by Mr. Bernanke as if the easing would start the next day!
I am not going to go into all the various indicators I use to value the current market. I’ve been told mathematical formulas are not very interesting, so bottom line we are still undervalued. Looking back to 2004, we can get a feel of how equities reacted when the Fed started to normalize their monetary liquidity stance to a more normal neutral rate. Over the next 12 months this cycle will begin but it will be gradual as Uncle Ben tests the waters.
Recent moves up in the forward P/E (price to earnings valuation based on the next 12 months) has now reached levels that have only been exceeded in the 1996 to 2005 environment. When you couple this with the low inflation outlook they are still too low. This is the result of lower inflation and higher productivity and lower rates. Using the forward P/E calculation the P/E should be 17.8 when the earnings on the S&P 500 is 116.30. Therefore, the market should be at 2070 instead of 1645. Now this calculation is not perfect but obviously the continued upward bias of the markets could be intact for an extended period.