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Fair Market Value Update

Written by: Doug Kass 04/30/12 - 12:00 PM EDT

  • I am increasing the probability of an above-consensus reacceleration in domestic economic activity (defined as +3% or more 2013 real GDP growth) from zero to 15%;

  • I am modestly increasing the chance of a recession in 2013 from zero to 5%;

  • I am lowering the probability of sub-1.5% 2013 real GDP growth from 35% to 20%; and

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  • I am slightly reducing the likelihood of my baseline, muddle-through scenario (defined as 2013 real GDP growth of between +1.5% and +2.0%) from 65% to 60%.

    • I am again increasing the theoretical P/E ratios attached to each of the four economic outcomes by half a multiple (+0.5). This reflects my expectation for a more benign inflation rate and a modestly lower interest rate assumption in 2013 relative to my prior projections.

    My base case of muddling through, with a six in 10 probability, yields an S&P price target of 1540, somewhat higher than my fair market value calculation of 1485. Below-consensus growth, which is accorded less than a one-third probability, yields an S&P target of 1290, which is well below both the current level of S&P cash of 1403 and my 1485 fair market value estimate.

    While there could be overshoots, in all likelihood, I expect the S&P 500 to be contained within the upper range of these two likely outcomes (which account for 80% of the outcome probabilities) of between 1290 and 1540 for the remainder of the year. Taken literally, this yields about 113 S&P points of risk from the current S&P cash level and about 137 points to the upside, for a more favorable risk/reward.

    As I have repeatedly written, my methodology, though appearing precise, recognizes the difficulty of attaining investment precision given the numerous moving parts (economic, interest rates, sentiment/psychology and exogenous factors) in its calculation.

    Below is the criteria and methodology I use to evaluate the S&P 500 and upon which I conclude that fair market value is approximately 1485, or about 6% above Friday's closing S&P of 1403.