Market Valuation – Is Intrinsic Value Higher Than the Current Market Price?

One measure of overall stock market valuation that we monitor is showing us that the intrinsic value of the market continues to grow, which is somewhat counterintuitive to what you might expect to happen after a 50% market rally. The methodology I’m referring to is a modified version of the Benjamin Graham intrinsic valuation model. This model was originally built for individual stocks, but The Leuthold Group, a well-respected institutional research firm, has modified it slightly to value a market index instead of individual companies. Recent calculations indicate that fair value on the S&P 500 Index is approximately 1,100. Since the S&P 500 is currently trading at about 1,000, it implies that the market is undervalued by approximately 10% (see chart below).

The increase in intrinsic value has been driven mostly by the dramatic improvements in credit markets that have occurred this year. As fear has abated and risk appetites have expanded, the AAA corporate bond yield has collapsed from 7.7% down to approximately 5%. This lower yield flows through the intrinsic value calculation and has driven the surge in fair value Some bearish pundits are screaming that the market is already overvalued after the equity rally we have experienced, and that is a reason to be underinvested in equity markets right now. Personally, I wonder how many of those pundits ignored the warning coming from credit markets before the financial collapse. Could it be that the credit markets are again well ahead of the equity markets in assessing the overall economic and financial landscape? If so, that might just leave further room for equity markets to firm and catch up to the positive message being projected by the corporate bond market.