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Minyan Mailbag: The Elephant



Editor's Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.


The IBES Valuation Model says SPX is undervalued by 40%.

Historic PEs say it's overvalued by 28%.

Isn't the resolution of this monumental disparity between these
gauges that have tended to agree the one real question we have to
deal with?

Minyan TR

PS: Seems like the 'Ville needs a new critter in residence.


A very interesting question. To be honest I don't know how IBES constructs its valuation model, but I have a feeling it is similar to Fed model. Where you take S&P earnings and divide it by prevailing interest rate. If that is the case, this model suffers from a major flaw - it is extremely sensitive to interest rate levels. Though I am less sure now than I was a month ago about interest rates going up, that in itself is an indicator that they are likely to do so. I am a big believer in mean reversion - and today's level of interest rates is far away from the mean. Thus personally I would put little value into the Fed's model.

Now let's look at historical averages. You are right based on historical averages S&P looks overvalued, and this doesn't even factor in the stock option expense and never ending one time items.

Most importantly current valuation level is really irrelevant - that sounds less than expected coming from fundamental guy (me). What is important that we are likely (if history repeats itself and tends to do that) moving from one extreme valuation level to another, and current valuation shows that we are not there yet. I described this in a lot more detail in this Financial Times article.

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