Fair Value

MARKET VALUATION AND ANALYSIS:

DATA:
US GDP 14.3 trillion 2008 (IMF time-series) and $11 trillion in 2005(wikipedia)
US Derivatives Market: 182.2 Trillion in May 2008 (wiki) and $298 trillion in 2005
US Market Cap: $40 trillion in Sept 2008, $57.5 trillion in May 2008 (wiki) and $17 trillion in 2005

GDP Yield (growth over 3 years) : 30% (like your "earnings" for company growth/returns yield)
Derivatives market yield (over 3 years): -39% <- probably more on the lines of -50-60% because of hedge fund liquidations
US Market Cap yield over 3 years (May): 238% (Price yield)
US Market Cap yield oer 3 years (Sept): 135% (Price yield)
US Total Market Yield over 3 years (May): -24%

ANAYLSIS:
US Total Market Value / Market Cap in May (Price-to-Book) = 240/57.5 ~ 4.2x
S&P500 average P/B: 2.84

Reduction Factor: 2.84/4.2 = 0.67 from avg May price 1400

Assuming Book value stays the same from May => 1400*0.67 = 938

S&P 500 P/E (May) ~ 24
S&P500 P/E (Oct 16) ~ 18.75 with S&P 500 price of 946
Goal: P/E = 15 (safe)

Reduction Factor: 15/18.75 = 0.8

Assuming Earnings stay the same from October 16: 946*0.8 = 756

SUMMARY:
My assumption for both of the above is as follows:
1. If we use book value vs earnings, we will get a difference because one will compare the growth story and the other will tell the valuation
story of the S&P / US Market.

2. Book value tells the valuation story of the core companies. If it could not grow anymore than the assets it already has, what would it have to work with. If we do some Price versus Book Value, Prices will go down because, from above, the US market cap has reduced by 1/2 between May and Oct. In the month of October, most of the problems have come from hedge fund liquidation which means that price, and book value will drop a little too but not nearly as much as price. Therefore, because of the drop in book value, price will have to drop more than the 938 that I have calculated.

3. Earnings tells us the growth story. If you take a look at the P/E ratio, you can see that if price and earnings both fell at the same rate, the ratio would be the same. However, because earnings are not necessarily all from price growth, the decrease by 1/2 of market cap will not correlate exactly to a decrease in 1/2 the earnings. Therefore, the ratio will stay higher than the P/E of 15 desired for safety because earnings will drop at a certain % of price creating a lower price outlook than 756 from a growth perspective.

*Valuation outlook for the S&P 500 will be about 20% below 938 because I believe that only ~20% (B/P = 1/4.2) of the book value is affected by the price fluctuation. Therefore, 938*.8 = 750.

*Growth outlook for the S&P500 will be about E/P = 1 / 18.75 = 5% below the 756 value because only about 5% of the earnings is affected by the price fluctuations.
Therefore, 756*.95 = 718.

Note: The reasons for these huge increases in market cap that highly exceeds the actual GDP growth is caused by a significant increase of shares (dilution of shares). I believe that a viable solution for this market recovering will be that because companies won't lend out to other companies, we will see a regression from publicly traded firms to more privately owned companies decreasing the amount of shares available and thus raising the value of the equity left standing. I think that this is a great opportunity for companies that have extra cash to instead of invest in other companies to instead, invest in themselves to restructure and re-image their business to fit a more globalized perspective. I believe that this effort was difficult to do in a ridiculously bullish market of 2003 to 2007 because this bullish attitude created a lot of short-term foresight in companies outlooks and focus.

RANGE OF FAIR VALUE FOR S&P 500: Low: 718 High 750.