Thoughts on Valuation, Money Flows

The S&P 500 closed last night at 1375.  That represents about a 7% decline from the market highs back in mid-September.  At this level stocks are trading about 13.25 times our end of the year $103.75 S&P 500 earnings.  Consensus estimates for 2013 stand somewhere between $111-115 per share.  I believe "Street" estimates are too high and I am using an earnings cone for next year between $107 and $111 per share.   I'll note that Wall Street started last year with much higher earnings expectations than I carried and the have come back to my level all year.  For purpose of this analysis I will use the lower end of my 2013 earnings cone and assume that the S&P 500 will earn closer to the lower end of the range next year.  I'll go into why I think that in a future post.

At current levels as stated above stocks trade at 13.25 my 2012 estimate and carry a 7.5% earnings yield {the inverse of its PE}.  The yield on the index is about 2%.  Assuming stocks can trade around a 14 multiple by year's end, the S&P 500 has the potential to trade up to a range between 1430-1460.  Note I say has the potential to trade up to this level, not necessarily that stocks will trade up there.  No guarantees.  Stocks are currently oversold enough by my work to stage some sort of a rally.    Seasonal trading also is favorable at this time of the year.  Any sort of resolution out of Washington regarding the "Fiscal Cliff" could provide the spark for a rally.  Conversely evidence that it is back to business as usual in Washington could place continued pressure on equities.

Using a $107 earnings assumption for 2013, stocks trade with a 12.85 PE and a 7.78% earnings yield.  Assuming stocks have the potential to trade with a 14-15 PE on these earnings, then stocks have the ability to trade up to 1500-1600 by year end 2013.  That is a possible gain between 9-15% by then.    Not saying we're going to get there but I'll note I consider my 2013 assumptions conservative unless Washington screws things up.  

*Long ETFs related to the S&P 500 in client and personal accounts.