Follow-up: Is the S&P 500 Index Fairly Priced?

Back on August 28th, we posted our trend analysis on whether the S&P 500 Index was over-priced based upon 5 basic long-term market trends (1932 to 2017). In this post we will take a look at a similar analysis for the shorter-term, post-recession S&P 500 Index (2010 to 2017). More specifically, we will compare expected market valuations based upon short-term trends for the following:

• Log (S&P 500 Index Price) vs. Time

• S&P 500 Index Price vs. Earnings

• S&P 500 Index Price vs. Dividends

• Log (S&P 500 Index Price) vs. Log (Earnings)

• Log (S&P 500 Index Price) vs. Log (Dividends)

First, lets look at the short-term growth rate of the S&P 500 Index from January 2010 to July 2017. The equation for the trend line is:

(Expected Value)S&P500 = 367.3 x (1.115497)^YR-2000 , R² = 0.9468

By substituting the numerical value of 2017.707 for 09/15/2017, we get:

(Expected Value)S&P500 = 367.3 x (1.115497)^{2017.707-2000}

(Expected Value)S&P500 = 367.3 x 6.92664

(Expected Value)S&P500 = 2544.16 (+1.9% relative to the 09/14/2017 close)

Second, lets look at the short-term linear relationship between Price and Earnings for the S&P 500 Index from January 2010 to July 2017. As you can see from this chart, the earnings correlation is poor (R² =0.5356). For this reason, this trend was ignored in the analysis.

Third, lets look at the short-term linear relationship between Price and Dividends for the S&P 500 Index from January 2010 to July 2017. The equation for the trend line is:

(Expected Value)S&P500 = 46.464 x (Dividends) + 106.14, R² = 0.9589

By substituting the latest Dividends of $47.19 for July 2017, we get:

(Expected Value)S&P500 = 46.464 x (47.19) + 106.14

(Expected Value)S&P500 = 2192.64 + 106.14

(Expected Value)S&P500 = 2298.78 (-7.9% relative to the 09/14/2017 close)

Fourth, lets look at the short-term linear relationship between Log (Price) and Log (Earnings) for the S&P 500 Index from January 2010 to July 2017. Again you can see from the chart that the earnings correlation is poor (R² =0.5633). For this reason, this trend was ignored in the analysis.

Fifth, lets look at the short-term linear relationship between Log (Price) and Log (Dividends) for the S&P 500 Index from January 2010 to July 2017. The equation for the trend line is:

(Expected Value)S&P500 = 63.973 x (Dividends)^0.928 , R² = 0.9591

By substituting the latest Dividends of $47.19 for July 2017, we get:

(Expected Value)S&P500 = 63.973 x (47.19)^0.928

(Expected Value)S&P500 = 63.973 x 35.755

(Expected Value)S&P500 = 2287.33 (-8.3% relative to the 09/14/2017 close)

By taking all 5 expected values and factoring in the respective correlations we get the following weighted average:

(Expected Value)S&P500 = 2376.76 (-4.8% relative to the 09/14/2017 close)

Comments: In conclusion, the 9/14/2017 closing price of 2495.62 for the S&P 500 Index is approximately 5% over-priced relative to short-term dividend and price trends (2010 to 2017) and now approximately 9% over-priced relative to long-term earnings, dividend and price trends (1932 to 2017) identified in the August 28 blog. Readers will note that the short-term correlations for the trends relative to dividends are significantly stronger than the respective trends relative to earnings (2010 to 2017). This emphasizes the importance of dividends as an indicator of market pricing, at least in the current market environment. Also, readers may note that the exponent for the formula in chart 4 is less than 1. This reflects a slow deflation in the trend of the P/D ratio since January 2010. This deflation means that there is a slow trend toward higher dividend yields between 2010 and 2017. Again, there may be some added safety by investing in higher-yielding securities, especially as interest rates may rise going forward. For the charts and trendlines, visit: http://ift.tt/2foxTci

Submitted September 15, 2017 at 02:51PM by DTRS_Investing http://ift.tt/2y44zib