Eye on the Market I October 9, 2012 J.P. Morgan A look at US equity valuations after the rally, and a fiscal cliff scorecard; South Carolina In 2012, rising equity markets have mostly been a function of rising multiples applied to modestly rising earnings. While we have had a normal weighting to US equities in model portfolios since mid-2009, I would've put no more than a 1 in 4 chance on a 17% advance in the S&P 500 this year. Forecasting annual equity returns is a treacherous exercise; the second chart shows how annual gains and losses in equities have completely swamped annual industry forecasts since 1950. S&P 500: earnings and PIE multiples $100 $98 $96 $94 $92 $90 7/1/2011 10/1/2011 1/112012 Source: Bloomberg, Factset. 4— S&P 500 Index Trailing 4-qtr EPS 4/1/2012 7/1/2012 10/1/2012 Futility of short-term equity market forecasting S&P 500, 12 month return, percent 60% - 13x 50% 40% 30% 12x 20% 10% 0% 11x .10% -20% .30% 10x 40% 1953 1960 1967 1974 1981 1988 1995 2002 2009 Source: RBC Capital Markets, Federal Reserve Bankof Philadelphia. --- Ex-ante S&P 500 Forecast — Ex-post S&P 500 Returns In any case, we're getting questions about where US equity valuations stand after the rally. To be clear, valuations might not be the driving factor at this point. The debasement of money by the Fed has altered the calculus of investing for many participants, and not necessarily for the better. An analysis we are still working on shows that since the Greenspan/Bernanke era of negative real interest rates began, stock market volatility is even higher than before the creation of the Fed in 1913, an era of recessions, depressions and widespread bank failures. Nevertheless, here's a look at the US equity valuation question, and what the current 13x-14x P/E multiple on the S&P 500 is worth in historical context. The traditional version of the Graham-Dodd/Shiller model makes equities look a bit expensive, cheaper only than the 1990