A simulation-based valuation of the S&P 500: July 2022

The figure below shows two simulation-based valuations of the S&P 500. They assume a fair price-to-earnings (PE) ratio for the S&P 500 that is the inverse of half of the 10-year U.S. Treasury yield. The price (at the top) is the most recent top value of the S&P 500.

The numbers on the left consider a rather benign scenario: S&P 500 earnings in 2022 are up by 10% from the previous year, and the 10-year U.S. Treasury yield is at 2.50%. The numbers on the right refer to a more likely scenario: S&P 500 earnings are down by 10%, and the 10-year U.S. Treasury yield is at 3.50%.

The second scenario takes us to a fair price for the S&P 500 of 2,638.16, which is 45.25% down from the most recent high. A sobering thought, given the rally that we are in right now, which many believe to be nothing more than another bear market rally.