After rallying 16% this year, the S&P 500 Index closed last year at its highest point since 2007, as investors celebrated news that central bankers were riding to the world's rescue with yet more stimulus. But is it too far too fast?
The answer is no, according to an old rule-of-thumb. A fundamental market valuation tool called "The Rule of 20" gives a quick-and-dirty picture, and at the moment, the market is undervalued by about 8%, and the fair value of the S&P is 1575. Here's the math: take the price to earnings ratio on the trailing 12-month GAAP (as reported) EPS and add the rate of inflation. If the number is 20, the index is fairly valued. If the number is over 20, the market is too rich, if under 20, it's a bargain.
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