What’s The Fair Value Of The Stock Market Right Now?
Valuing The S&P 500
Not intended to be investment advice. If you would like to replicate my calculations, you can get my code from my GitHub here. Sorry, it’s a bit messy. The S&P 500 data can be downloaded here.
I try to make a habit of checking the fair value of the S&P 500 every now and then. It’s a subjective and approximate estimate, but keeping in mind roughly where the fair value of the stock market is allows us to position our portfolios appropriately (in terms of risk exposure) based on the odds that the market is giving us.
When the market is cheap, it’s giving us great odds — as long as the future unfolds just a bit better than the pessimistic outlook that is being discounted (discounted here means implied by market prices), we will make money. Regression to the mean helps us.
When the market is expensive, the odds are not as good. It doesn’t mean that we will lose money necessarily. But economic outcomes will have to be even better than the above average outcomes that are being discounted for us to make money. In this case, regression to the mean hurts us.
When the odds are not in our favor, it doesn’t make sense to go all-in on risky assets. Rather, it’s prudent to be a bit more selective in terms of both the amount of stocks…
