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S&P 500 Trails ‘Very Fair’ Value After Losses: Chart of the Day

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.

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