Valuation Parameters For 2009

It is looking increasingly like a mid $60 operating earnings number will be the full year result for the S&P 500 for 2008. With the index trading in the upper 800 range, the current P/E is settling in around 13 times (874/$65 = 13.45).

Since P/E ranges are dependent upon the economic scenario, the accompanying table (click image to enlarge) of P/Es and possible 2009 operating earnings provide a framework for where fair value might reside in the year ahead.

You will note that I have excluded certain projected price levels as the economic scenario does not apply to the corresponding operating earnings. (For example, one cannot assume a “great times” P/E of 20 if operating earnings plunge to $52. Conversely, neither can one assume a deflationary scenario with operating earnings rising significantly to $82.)

Investment Strategy Implications

While a highly unpredictable climate awaits investors in the year ahead, the accompanying valuation table provides some guidance as to where fair value resides. From where I sit, driven largely by a more resilient global economy and the “surprise” write-ups of “toxic assets” held on bank balance sheets, the fair value level for 2009 is 1050 (14 x $74 = 1050). That’s a 20% return from current levels.

Wishful thinking? Perhaps. Given all the risks that remain (including the threat of protectionism and other geopolitical tensions as well as further forced liquidations due to further hedge fund redemptions (estimated by Mary Ann Bartels (Merrill Lynch) at an additional $100 billion), a cautionary approach is understandable. However, I suspect that governments acting in their collective economic self interest will result in a global cooperation that will produce better economic results than many currently believe. Moreover, it is hard to envision the $3.5 trillion of money market assets sitting idling by at near zero rates of return indefinitely, thereby alleviating the capital pressures on the economy and markets.

Wishing you a very happy and successful New Year.