There was a very interesting interview with famous investor Lee Cooperman on CNBC today where he discussed his basic framework for thinking about stock market valuation.
To value the stock market, he finds it useful to think about what a ‘normal’ economy looks like (He doesn’t think we’re in a normal economy now with many country’s bonds offering negative or near zero interest rates).
In a ‘normal’ economy he assumes population growth of .5% and productivity growth of 1.5% for a real GDP of 2%. If you had 2% inflation that means you have a nominal GDP of 2% + 2% = 4% which means 10 year bonds should be ~4% also and the federal funds rate should be a little lower at ~3%.
In that environment, he believes a fair valuation for the S&P500 is 16-17x forward earnings. He’s assuming $170 for S&P earnings in 2019, which means fair value in that world would be between 2720 and 2890 (which is about where the market is today).
He didn’t say this, but implied in his reasoning is that if we’re in a lower interest-rate world (like we are today) the stock market should trade at a richer valuation.
According to FactSet, the average 5 yr forward P/E on the S&P is 16 and the 10 yr average is 14.3. You can read more about that in our post on S&P earnings estimates and price targets
Lee Cooperman also commented on the 4 things he thinks can cause a big selloff in the stock market. They are:
- A recession
- A hostile fed that raises interest rates too much
- Speculative valuation levels (like in 2000)
- A geopolitical event (which are often impossible to foresee)
You can see the full interview here (~12m long):
https://www.cnbc.com/video/2019/02/26/watch-cnbcs-full-interview-with-lee-cooperman.html