Back on August 28th, I provided a table that listed various economic outcomes using simple, yet direct terms, such as “average times”, “great times” and “terrible times.” Accompanying each economic outcome was a P/E ratio and earnings outlook that, when multiplied with each other, produced a valuation level for the S&P 500.

I am now providing an updated and evolved version of that data that should help investors frame the current economic and market environment.

Below is a simple Excel chart that uses a probability approach. Last Friday’s data shows a market that was significantly undervalued (return potential of +17.90%). The economic scenarios are listed in simplistic terms with the corresponding P/Es that typify the times.

Look at the interplay between the P/E ratios for each economic scenario and the 12- month ahead operating earnings for the S&P 500. Note that different conditions require different inputs, most markedly in the terrible times scenarios.


Click here to enlarge.

Investment Strategy Implications

You might argue with the inputs; but, what can’t be disputed is the process – one that any investor can construct and use to great effectiveness. According to my work (expressed in the above table), a conservative valuation level for the S&P 500 in the current market climate should be no less than 1033.94. This number will rise and fall as the data from the economy and other factors come into play and the probabilities and earnings are accordingly adjusted.

By creating this kind of spreadsheet, any investor can remove the mystery of valuation levels for the overall market, provided they can get the inputs correct. And that’s the real hard part of this game we call investing.