Published September 04, 2012
Thanks mainly to President Barack Obama and his anti-business rhetoric, lack of clarity on future regulation and growth-suffocating policies, stocks are currently 20% undervalued.
What makes this even more gut wrenching is the fact that, based on how stocks are valued on Wall Street, with the 10-year Treasury at the lowest levels historically, stocks should actually be 15% overvalued.
As many of you know, stocks will move up or down 6 to 9 months ahead of earning reports being released, as stocks are usually a great predictor of future news.
Stocks are sometimes valued based on a ratio called the price-to-earnings ratio, or the P/E ratio. As a general rule, your P/E ratio should be close to the growth rate of a company or industry.
After collecting all of the earnings estimates for the S&P 500 companies from the major research shops on Wall Street, I have calculated those earnings estimates to be $101.69. With the S&P 500 currently at 1407, it has a P/E of 13.8. Based on growth projections, this is ridiculously low.
When the 10-year Treasury is as low as it is, the appropriate P/E for stocks is about 18. This is based solely on the comparison of how much more attractive stocks are relative to bonds. To use a sports analogy, if this was a boxing match, stocks would win the competition in the first round with a knockout punch.
If there was a positive feeling about the stability of the economy and growth prospects for the country, we would expect to see the stock market 30% higher. Sages on the Street agree with me, and support the view that the S&P 500 should be at 1830, not 1407, and the Dow Jones Industrial Average should be at 17000, not 13090.
It is very simple math: if we had a president that evoked hope and fostered a positive business climate rather than demonizing corporations and success, most 401(k) plans and investment portfolios would probably be 30% higher.
The positive ripple effect of higher stock prices would result in more jobs, thus bringing down unemployment, raising bonuses, and putting more money in the economy. Anyone with baseline knowledge of investing knows this position is hard to debate.
Ed Butowsky is managing partner at Chapwood Investments and an internationally recognized wealth manager.