Stocks could recoup all of the past month’s losses before reaching “very fair” prices, according to David Bianco, chief U.S. equity strategist at Bank of America Merrill Lynch.
The Standard & Poor’s 500 Index ought to be valued at 14 times to 16 times earnings because 10-year Treasury notes yield next to nothing after adjusting for inflation, Bianco wrote two days ago in a report. The index, which fell 13 percent in the last month, closed yesterday at about 12 times his profit projection for this year.
The CHART OF THE DAY compares Bianco’s price-earnings range with annual ratios during the past half-century, as cited in his report. The figure for 2011 is an estimate, based on his projections that the index will end the year at 1,400 and S&P 500 companies will earn a combined $97 a share.
“Low rates benefit P/E more” than slowing economic growth hurts the ratio, he wrote. Each one-percentage-point decline in the real yield on 10-year Treasuries increases the fair P/E by as much as 20 percent, by his calculations.
This year, the note’s unadjusted yield fell 1.07 points through yesterday to 2.23 percent. Bianco assumed a 3 percent year-end yield and inflation rate in his report, resulting in zero real return.
Bianco’s P/E range points to a 6 percent to 7 percent annual return on the S&P 500 after inflation, which he called “both fair and attractive” in the report. During the past half-century, the index’s real return averaged 5.4 percent annually, he wrote.