Tuesday, April 8, 2008

Fair Value Target for S&P 500: 1420

As 1Q08 gets into full swing and reality begins the process of bringing bottom-up analyst forecasts toward some semblance of reality, investors should not lose faith in the spring equity respite. For example, according to the very reliable proprietary Expected Return Valuation Model (ERVM), 1420 for the S&P 500 combined with a 3.70% level for the 10 US Treasury would put US stocks in the lower end of the fair value zone*.

Accordingly, at 1420, the expected return (next 12 months) for stocks falls into the 11 to 15% range, which wraps very nicely around the historical rate of return for large cap stocks of 12%. (Moreover, should the credit crisis diminish with credit spreads narrowing, the potential for overshoot exists as the ERVM risk adjusted range might slide from from its current 120 - 140 basis points over the 10 year Treasury to a more normal 100 to 120 basis points range thereby moving the fair value target to 1470.)

Interestingly, 1420 for the S&P 500 is also right around its 200 day exponential moving average**, which will likely generate some banter among pundits.

Investment Strategy Implications

Sell-offs due to downside earnings surprises (to bottom-up analysts) this earnings season should produce a fair number of good near term buying opportunities.

*at $80 operating earnings
**click on image to enlarge

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